The Economy Comes Back
By Nayyer Ali MD
Five years after the start of the biggest economic downturn since 1929, the US economy is finally starting to come back. The downturn was vicious and sharp, shrinking output by 5% and throwing 9 million people out of work in less than 18 months. A deep recession is usually followed by a strong recovery, at least that has been the pattern since World War II, but this time the economy was sluggish with poor growth and job gains for several years, while the weak economy gutted the tax base of both the Federal and state governments, resulting in huge budget deficits and massive layoffs of teachers and policemen and other government employees, particularly at the state and local level. Unlike all other recessions, this one was unique in that the government workforce has actually shrunk over the last 5years, with about 1 million fewer government workers than in 2007.
The economic recovery has been so slow primarily because the main force that leads recovery, a sharp increase in housing construction and sales, was blocked by the aftermath of the housing bubble. Even now, housing starts are half that of a normal economy. The other factor, brought on by the housing collapse, has been the weakness of the banks and the tightening of credit. Even if you wanted to buy a house, it was much harder after 2008 to qualify for a loan.
The severe downturn exploded the Federal budget deficit, which is the amount the government has to borrow and add to the national debt to cover expenses when taxes are not sufficient. The numbers are huge, so it is better to think of them in terms of percent of the economy (GDP). In good times, the budget deficit runs around 1-2% of GDP, and under Clinton it actually turned into a surplus during his last three years. Obama entered in 2009 with the deficit at 10% of GDP. Raising taxes was not an option given the state of the economy, but cutting spending was also a bad idea. What the economy needed was some source of spending to make up for the hole created by the collapse of the private sector.
Small countries can sometimes devalue their currency and grow exports as an engine of recovery, but the US is too big for that. Cutting interest rates to zero by the Federal Reserve would normally work, but in a depression scenario (which is what we are in), even at zero interest rate the demand for credit is insufficient to restore the economy. It is a moment like this when temporary government spending can be a lifesaver, which is what Obama did with his stimulus plan in 2009. The only problem was that while it was big enough to prevent a more severe collapse, it was too small to restore employment and fill the hole.
But with enough time passing, the economy is finally turning upward. At this point we are now 3% larger than the last peak in 2007. Employment, which peaked at 138 million people in 2007, fell all the way to 129 million by end of 2009. We are now back to 136 million people working, and if the government had not shrunk, another million people would be on the job. Housing is finally recovering, with prices finally rising across the country and much of the foreclosed properties disposed of. New home starts are picking up, adding construction jobs.
These trends are adding to government tax receipts. Back in 2012, it looked like the budget deficit this year would come in around 6% of GDP, but the latest numbers are looking even better. Goldman Sachs expects the deficit to be 775 billion dollars, which is 4.7% of GDP. Still not ideal, but at least not wildly out of control, and less than half of the peak of 2009. Some economists argue strongly that in fact we are shrinking the deficit too quickly. If we spent another 100-150 billion a year to help states and local governments hire back their staff, we could boost the economy rapidly.
The government workers would be able to spend and that spending would boost new jobs in the private sector. With borrowing costs below the rate of inflation, it makes sense to borrow money now and restore the economy to full employment. But that is not going to happen with the Republicans in charge of Congress. Instead we will have to let this play out slowly but surely. Politically, this is going to set up the Democrats quite well to win the 2016 Presidential election. By then the budget deficit will be under 3% of GDP, and the economy will be even stronger. Not much for the Republicans to run on.