The Wall Street Journal
SEPTEMBER 2, 2010
Summer of Economic Discontent
The administration's 'summer of recovery' has fizzled in almost every way imaginable. The growth rate is less than half what it was at this stage after the 1974-75 and 1981-82 recessions.
By MICHAEL BOSKIN
The Obama administration's "summer of recovery" has morphed into a summer of economic discontent amid anxiety over the weakening economy. The greater than 4% growth and less than 8% unemployment envisioned by the president's economic team are nowhere to be seen. Almost everything that is supposed to be up—the economic growth rate, the stock market, bond yields—is down. And almost everything that is supposed to be down—unemployment-insurance claims, new mortgage delinquencies—is up.
Sometimes a weak early recovery gathers strength after a year or so, as in 2003 when the second round of the Bush tax cuts helped double growth to 3.8% from 1.9%. But there are serious headwinds to stronger growth: household deleveraging, unresolved toxic assets, and most government economic policies headed in the wrong direction. While the base case outlook is still slow recovery, a double-dip recession or a Japanese-style lost decade is more plausible than a few months ago. This explains why Federal Reserve Chairman Ben Bernanke felt compelled last week to reiterate that the Fed will use more of its (in my view, weak) ammunition should the economy falter further.
How bad is it? In the data for the last few weeks and months, real personal disposable income was flat; core capital goods orders, a precursor of business capital spending, declined 8%; new home sales fell 12.4%, existing sales 27%, despite record low mortgage rates; single-family housing starts declined 4.2%; building permits, foreshadowing future construction, fell 1.2%; initial jobless claims spiked to over 500,000, leading forecasters to expect at best meager short-term private-sector job growth; the Kansas City, Philadelphia and New York Fed manufacturing indexes fell; and the trade deficit increased, as exports fell and imports rose.
These weak backward-looking data were accompanied by big downdrafts in forward-looking financial markets. The Dow Jones Industrial Average lost over 4% and the tech-heavy Nasdaq over 6% in August—partly retraced yesterday—and the 10-year U.S. bond yield, at 2.47%, was back to its lows of March 2009. Real GDP growth slowed from 3.7% in the first quarter to just 1.6% last quarter.
Worse yet, much of the growth in the first half of 2010 was due to inventory-rebuilding; real final sales grew at only about 1%. Consumers are cautious, saving and paying down debt. The surge in government spending is abating. Global trade, dependent on growth abroad, is slowing: Japan is stalled, China slowing, and despite Germany's strong quarter, eurozone growth is projected to be only half America's modest rate through 2011.
The one bright spot has been the rebound in business capital spending. Businesses are flush with cash and profits have been solid. But the weak core durable goods report, the manufacturing downshift, and continued uncertainty about the economy and the Obama administration's economic policy have many forecasters reducing capital expenditure projections.
The sluggish growth is particularly disconcerting compared to the usual strong growth following deep recessions. The chart nearby shows the average real growth that occurred in the first four and first 12 quarters following the severe recessions of 1974-75 and 1981-82. Compared to the 6.2% first-year Ford recovery and 7.7% Reagan recovery, the Obama recovery at 3% is less than half speed. The unemployment rate would now be 8% or lower at those higher growth rates. If the Obama recovery continues at 3%, the president will be running for election in mid-2012 with a cumulative GDP recovery shortfall of 4.5% (relative to Ford) to 8.4% (relative to Reagan).
President Reagan won re-election with 49 states. President Ford came from 30 points back to lose narrowly to Jimmy Carter, and would have won easily were the election a few months later. What does this say about an Obama second term? With little discernible improvement in the economy from the president's $862 billion in fiscal stimulus, citizens are revolting against the explosion of spending, deficits, higher taxes, government bailouts and economic micromanagement, and seem poised to put an exclamation mark on it in the November elections.
Not surprisingly, the left is frantically calling for a second "stimulus" and demanding tax hikes for the "rich"—a.k.a. our most productive citizens and small businesses. The rehashed ideas include such nonsense as massive infrastructure spending financed by a national infrastructure bank, an old Carter idea; yet more aid to the states; and even that worst of ideas, "general revenue sharing," which would force citizens to pay future federal taxes to fund the debt used just to send revenue back to their states.
These ideas would do a lot more harm than good. To paraphrase Benjamin Franklin, we have the best economic system among the advanced economies, "if we can keep it." That will require fundamental policy changes, not doubling down on the failed big government experiment of recent years.
The president and Congress would have to implement serious spending reductions, real entitlement reform focused on substantially slowing the growth of benefits per recipient, and no tax hikes. President Clinton made a major move back to the political center—to his own and the nation's benefit—when Republicans won control of Congress in 1994. In partnership, they balanced the budget and reformed welfare. But recall, President Clinton's major big-government initiative—HillaryCare—was defeated. For President Obama to get to a similar place after the midterm elections, he would have to partner in "repealing and replacing" his signature initiatives.
Mr. Boskin is a professor of economics at Stanford University and a senior fellow at the Hoover Institution. He chaired the Council of Economic Advisers under President George H.W. Bush.