Excerpts from Larry Summers article in FT:
Even with the 2008-2009 policy effort that successfully prevented financial collapse, the US is now halfway to a lost economic decade. In the past five years, our economy’s growth rate averaged less than one per cent a year, similar to Japan when its bubble burst. At the same time, the fraction of the population working has fallen from 63.1 per cent to 58.4 per cent, reducing the number of those in jobs by more than 10m. Reports suggest growth is slowing.
A sick economy constrained by demand works very differently from a normal one. Measures that usually promote growth and job creation can have little effect, or backfire. When demand is constraining an economy, there is little to be gained from increasing potential supply. In a recession, if more people seek to borrow less or save more there is reduced demand, hence fewer jobs. Training programmes or measures to increase work incentives for those with high and low incomes may affect who gets the jobs, but in a demand-constrained economy will not affect the total number of jobs. Measures that increase productivity and efficiency, if they do not also translate into increased demand, may actually reduce the number of people working as the level of total output remains demand-constrained.
Traditionally, the US economy has recovered robustly from recession as demand has been quickly renewed. Within a couple of years after the only two deep recessions of the post first world war period, the economy grew in the range of 6 per cent or more – that seems inconceivable today. Why?
Inflation dynamics defined the traditional postwar US business cycle. Recoveries continued and sometimes even accelerated until they were murdered by the Federal Reserve with inflation control as the motive. After inflation slowed, rapid recovery propelled by dramatic reductions in interest rates and a backlog of deferred investment, was almost inevitable.
After bubbles burst there is no pent-up desire to invest. Instead there is a glut of capital caused by over-investment during the period of confidence – vacant houses, malls without tenants and factories without customers. At the same time consumers discover they have less wealth than they expected, less collateral to borrow against and are under more pressure than they expected from their creditors.
What, then, is to be done? This is no time for fatalism or for traditional political agendas. The central irony of financial crisis is that while it is caused by too much confidence, borrowing and lending, and spending, it is only resolved by increases in confidence, borrowing and lending, and spending. Unless and until this is done other policies, no matter how apparently appealing or effective in normal times, will be futile at best.
The fiscal debate must accept that the greatest threat to our creditworthiness is a sustained period of slow growth. Discussions about medium-term austerity need to be coupled with a focus on near-term growth. Without the payroll tax cuts and unemployment insurance negotiated last autumn we might now be looking at the possibility of a double dip. Substantial withdrawal of fiscal stimulus at the end of 2011 would be premature. Stimulus should be continued and indeed expanded by providing the payroll tax cut to employers as well as employees. Raising the share of payroll from 2 per cent to 3 per cent is desirable, too. These measures raise the prospect of sizeable improvement in economic performance over the next few years.
Now is not the time to defer infrastructure maintenance and replacement. We should take advantage of a moment when 10-year interest rates are below 3 per cent and construction unemployment approaches 20 per cent to expand infrastructure investment.
It is far too soon for financial policy to shift towards preventing future bubbles and possible inflation, and away from assuring adequate demand. The underlying rate of inflation is still trending downwards and the problems of insufficient borrowing and investing exceed any problems of overconfidence. The Dodd-Frank legislation is a broadly appropriate response to the challenge of preventing any recurrence of the events of 2008. It needs to be vigorously implemented. But under, not overconfidence is the problem, and needs to be the focus of policy.
Policy in other dimensions should be informed by the shortage of demand that is a defining characteristic of our economy. The Obama administration is doing important work in promoting export growth by modernising export controls, promoting US products abroad and reaching and enforcing trade agreements. Much more could be done through changes in visa policy to promote exports of tourism as well as education and health services. Recent presidential directives regarding relaxation of inappropriate regulatory burdens should also be rigorously implemented.
Perhaps the US’ most fundamental strength is its resilience. We averted depression in 2008/09 by acting decisively. Now we can avert a lost decade by recognising economic reality.
Good comment:
What has been completely ignored in this article is the structural change in US economy. Multi-nationals have moved as many jobs abroad as possible. Recession was even used by some to cut down positions in US (they were replaced by positions in China etc.). Why else would corporate profits go on rising when economy is barely growing? Consumer spending counts for about 70% of GDP and unless unemployment goes down, we can forget consumption and hence recovery too. This is a structural shift in our economy and if it continues, 9% unemployment is here to stay.
Rising inequality is also one of the major reason for this lackluster recovery. Rich spend less % of their wealth, pay less tax (thanks to bush) and are capable of investing their savings in emerging markets with better returns (instead of investing in the US). So the US does not benefit much from one person making a billion, instead it needs 20,000 people making $50,000.
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