The American Recovery Is Likely to Be Illusionary J. Bradford DeLong Professor of Economics, U.C. Berkeley Research Associate, NBER firstname.lastname@example.org July 26, 2009
The United States of America just has or will soon see the bottom of the business cycle, at least as far as the semi-official National Bureau of Economic Research counts such things. But even though a recovery has just begun or is about to begin, the recovery will not feel like one. From the perspective of the people’s livelihood of the average American worker—and from the perspective of its impact on American politics—the economic downturn is more likely than not to drag on for quite a while yet.
At the Bottom of the Business Cycle The financial crisis gathered force from the summer of 2007 through the summer of 2008. It then exploded into macroeconomic catastrophe after the collapse of Lehman Brothers last fall. It did more damage to the American economy than most forecasters had dared to imagine, even in their worst fears. Last December, the conventional wisdom and consensus forecasts of economists was that in the year 2009 the official headline unemployment rate in the United States as reported by the federal
government’s Department of Labor and its Bureau of Labor Statistics would average something like 7.8 percent. Yet as of this writing the average unemployment rate for 2009 seems more likely than not to be above 9.3 percent or higher—at least 1.5 percentage points higher than was estimated only seven months ago. Year-2009 real GDP in America also looks to be lower than predicted—likely, as of this writing, to come in at $11.40 trillion rather than at the $11.53 trillion forecast by the incoming Obama administration only last December. It is worth pausing to notice the relative size of those two magnitudes. The unemployment rate will be 1.5 percentage points or more above its forecast as of last December. Real GDP will be 1.2 percent below its forecast back as of last December. Back in the 1960s one of President Johnson's economic advisers, economist Arthur Okun from the Brookings Institution, set out a rule of thumb that was then quickly named “Okun's Law.” Okun found that if the workings of the industrial business cycle were causing real GDP in the United States to rise or fall by a bit over two percent, then you could expect that the American unemployment rate would fall or rise by one percent. The magnitude of swings in unemployment was always roughly a little bit less than half the proportional magnitude of the swings in real GDP. This was thought to be the case for four reasons: •
First, American businesses had a tendency to “hoard labor” in business cycle recessions—seeking to keep their useful workers around and on the payroll even when there was temporarily nothing for them to do on the factory floor.
Second, American businesses would cut back hours whenever unemployment rose, reducing output more than proportionately than the number of workers because total hours worked will fall by more than total numbers employed.
Third, plant and equipment in American factories would run less efficiently when hours were artificially shortened.
Fourth, some workers who lost their jobs did not show up in the unemployment statistics, because instead of reporting themselves as unemployed they chose to retire or to drop out of the labor force altogether.
For all four of these reasons, the rise in the unemployment rate during America’s business cycle recessions used to be a fraction of the decline in real GDP relative to trend. According to Okun's Law, the unexpected extra 1.2 percent decline in real GDP in 2009 should have been accompanied by a 0.5 or 0.6 percentage-point rise in the unemployment rate. Instead, the American economy looks likely to experience a 1.5 percentage point rise in the unemployment rate. I confess this comes as a surprise to me, but it should not. The evidence that Okun’s Law has been broken—especially with regard to the retention of workers in a downturn—has been mounting for decades: •
In 1993—two full years after the National Bureau of Economic Research said that the 1990-1991 recession in America had ended—the unemployment rate was still higher, and the employment-to-population ratio lower, than it had been at the recession’s trough.
In 2005—four years after the end of the recession of 2001—the American economy was still seeing this same kind of “jobless recovery.” It was not until 55 months after the 2001 NBER recession trough called an end to America’s post-dot-com-bubble downturn that a greater share of Americans were working than had been working when real GDP was at its lowest.
Now in 2009, the American economy is starting once again to show signs that its economic recovery will be “jobless”: real GDP will grow, but the unemployment rate will increase, the employment-to-population ratio will
fall, and real wages for average, for poor, and for above average but not rich workers will stagnate. So get ready for another jobless recovery. One question is, why the shift? What has become different in the Americn economy over the past two decades? Paul Krugman has a theory: “[Past] recessions . . . were very different. . . . Each of the slumps—1969-70, 1973-75, and the double-dip slump from 1979 to 1982—were caused, basically, by high interest rates imposed by the Fed to control inflation. In each case housing tanked, then bounced back when interest rates were allowed to fall again. Since the mid 1980s, however . . . recessions haven't been deliberately engineered by the Fed, they just happen when credit bubbles or other things get out of hand. . . . [T]hey've proved hard to end . . . precisely because housing—which is the main thing that responds to monetary policy—has to rise above normal levels rather than recover from an interest-imposed slump.” I would guess—but it is only a guess—there is a second set of factors at work as well here in America. Manufacturing firms used to think that their most important asset was their skilled and experienced workers. Especially when economic recovery began, firms did not then want to lose hold of their prime productive assets. Skilled workers were the franchise. Now, by contrast, it looks as though American firms think that their workers are much more disposable—that their brands or their machines or their procedures and organizations are the key assets that they must safeguard. They do not need to keep hold of their current workers, however, to keep the firm productive. American firms, however, still want to keep their workers happy in general. The hypothesis is that firms believe that their remaining workers will not be upset if they fire employees and speed-up the pace of operations near the bottom of a downturn. The firm will plead that the reductions in the labor force and the changes in work rules are forced upon
it by economic necessity, and workers will accept that plea at the bottom of a recession but, not at other times. Hence the start of the recovery is American business's last moment to slim down its labor force and become more efficient and thus more profitable in the coming business-cycle expansion. That, at least, is the theory and my guess. At least Americ is likely to see an economic recovery. The prevailing forecast right now is for real GDP to contract at a rate of one percent per year or less between the first and second quarters of 2009, followed by growth between the second and third quarters at an annual rate of two percent or so. When the NBER Business Cycle Dating Committee gets around to it, it is most likely to call the end of this recession for June 2009, with the second most likely call for April and a date sometime after June 2009 as a less likely possibility. Yes, that would mean the recession is over right now. One reason for that is the much-maligned stimulus package, which probably boosted the real GDP annual growth rate by about one percentage point in the second quarter of 2009, and will boost it by another two percentage points between now and the summer of 2010. This matters because it means that American demand for imports is likely to start growing again… now. But it also matters politically. The political question “Did the Democratic Party’s stimulus package work?" well be answered with a “yes” if observers focus on real GDP and on the NBER business cycle turningpoint dates. Democratic-Party members of Congress seeking reelection in 2010 will be able to point to real GDP growth and an official end to the recession in the second quarter of 2009. However, that is probably not the most relevant political question to ask, and not how the issue is likely to be framed. Comparing the second quarter of this year to the first, work-hours in America have declined at a rate of
six percent annually. Work-hours from the second to third quarter are likely to decline at a rate of about three percent per year. These numbers imply that American productivity is now growing at five percent per year—not because of investments in new technology, but rather instead because businesses will continue to fire workers in the belief that remaining workers will accept their plea of economic necessity. If the question in the 2010 and 2012 elections becomes “Did the Democratic Party make it easier to find a job or get a raise?” the answer will probably be no. And this matters. A return to power of the Republican Party in spite of its very disappointing policy performance between 2000 and 2008 is not out of the question. And an attempt to escape political dilemmas by blaming foreigners—especially Asians and the manufactured goods they make—for high American unemployment is not out of the question either.
July 26, 2009: 1668 words.
Professor of Economics, U.C. Berkeley Research Associate, NBER At the Bottom of the Business Cycle email@example.com July 26, 2009 1...