By Dr. Nayyer Ali

June 17, 2011

Can the American Economy Be Fixed?


The May job report was a massive disappointment, with only 50,000 jobs created and the unemployment rate going back up to 9.1%.  Two years after the recession technically ended, the nation faces persistently high unemployment and a large output gap between what the economy is producing and what it is capable of. 

Obama tried extra government spending and tax cuts (the “stimulus plan”), but while it may have ended the nosedive, it has not restored health.  The Federal Reserve has cut interest rates to zero and kept them there, and has pushed down long-term rates by buying government debt, and yet that has not helped the economy visibly. 

The Republicans on the other hand believe the problem is Obama, his health care reform, excess government spending, high budget deficits, and that everything would be just fine if we cut spending.  They would like to blame tax increases, but Obama has not increased taxes, as a share of the economy we have never had lower taxes than we have had for the last two years.

So what is wrong?  Unlike previous recessions, which are brought on by excessive strong growth, rising inflation, and rising interest rates needed to bring that trend to a halt, this recession is due to a massive financial crisis brought on the popped housing bubble.  The end result is millions of households with foreclosed homes, bankruptcies, and a moribund housing market that results in two million construction jobs which are missing.  Housing and construction and finance are all sectors that often lead economic recoveries, but this time they remain depressed. 

Corporate America on the other hand is doing quite well.  Stocks have rebounded almost 100% since March 2009, and corporate profits (except for the banking sector) are at record highs, along with stock prices outside the financial companies.  Obama has been good for business if we measure by profits.  So why aren’t all these profitable companies hiring like mad and expanding operations?

What America has is a lack of economic demand that is keeping American business afraid to hire.  We are stuck in a depressed state in which consumer demand is suppressed due to millions without work because business won’t hire, while business won’t hire because they don’t see enough sales growth from consumer demand to justify hiring.  How to break this chicken and egg problem?

The world economy faced this exact situation 80 years ago during the Great Depression, and classical economic theory was at a complete loss to explain why high unemployment persisted for years.  It was the brilliant British economist John Maynard Keynes who saw through the fog and showed that the way out was to artificially boost consumer demand by public spending with borrowed money.  In other words, governments should run massive budget deficits and spend like crazy to put money in people’s pockets.  Those consumers would then start buying goods and services, businesses would rehire, and the depression would be broken.  In fact that is what happened. 

It was massive deficit spending under Roosevelt that lifted the economy, and it was the very large deficits of World War II that finally returned America to prosperity and full employment. 

Over the next few decades, Keynes’ prescription for curing depression began to be misused as a way to avoid even minor recessions.  The result was too much deficit spending and persistent economic stimulus that culminated in the wave of inflation in the 1970s.  That experience soured many on Keynes, and some suggested that he was fundamentally wrong and not insightful.  But this Great Recession is proving again how correct Keynes was.  To get out of this cycle, we need to spend more and run bigger deficits.

Politically though that is not possible.  The American people, particularly conservatives, are convinced that high budget deficits are a threat and a cause of our economic difficulties.  The Republicans are currently trying to use the debt limit ceiling issue to force Obama into immediate and severe budget cuts.  This would be a disaster for the US economy.  The last thing we need right now is less spending or higher taxes.  It is true that in the long run America’s fiscal path is unsustainable, but that is almost entirely an issue of the long run cost of the Medicare program.  We have plenty of time to deal with that in 2015 or later. 

The immediate priority must be to get the economy restarted.  Our current deficits are almost entirely due to the Bush tax cuts, the wars, the effects of the recession, and to a much lesser extent, the stimulus spending of Obama.  These can all be reversed in due time, just not right now.  The Republicans are very happy to blow up the American economy as long as Obama gets the blame.  Obama has another 12 months or so to visibly improve the economy.  If we are still in poor shape next summer, his re-election will be in marked jeopardy.  His only hope will be that the Republicans nominate an extreme candidate who can’t win, which is a possibility.  But I think that they will come to their senses and put forth either Romney or perhaps Pawlenty, and both have an excellent chance of beating Obama.     



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Speaking to Non-Muslims

If Arafat Were Jinnah

The Shape of Things to Come

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Kashmir Quagmire: How It Started

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Our Growing Community

Pakistan’s Golden Opportunity

Musharraf’s Reform Plans

Pakistan’s Afghan Dilemma

Humanity on the Move

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Winners and Losers

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Bush’s Stem Cell Compromise

The Depressing Stock Market

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Zakat and Capitalism - 2

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Bush Attacks

Besieging Baghdad

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The End of Saddam Hussein

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Kerry's Big Wins

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Bush's Growing Vulnerability

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Abuse at Abu Ghraib

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Editor: Akhtar M. Faruqui
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