The Risks of Reviving a Revived Economy

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Illustration by Harry Campbell for TIME

The 2% economy—what caused this slow-growth cycle and what might cure it—was the make-or-break issue of the 2012 presidential election. It’s also the most pressing issue for the President now.

Sure, getting Congress to pull back from the fiscal cliff is Job One. But beyond that, we’re actually at a crucial economic crossroads. History shows that four to five years after a financial crisis is usually when a country either moves slowly but surely into a sustained recovery or lapses back into recession. The President can’t control many of the variables involved: the euro zone might dissolve, or China could have a hard landing; either situation could tank growth in the U.S. The President can, on the other hand, determine whether and how the government keeps spending to boost the recovery, who should pick up the tab and which Americans will bear the brunt of the inevitable budget cuts on the horizon.

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There was plenty of talk during the campaign about the extent to which the Obama Administration’s fiscal stimulus and the Fed’s sustained money drops have helped or hurt the economy since 2008. Let’s be clear: it’s the reason we didn’t go into another Great Depression.

Ironically, the stimulus is also a reason the recovery has been so slow and will continue to be for the next three to five years. Harvard economist Ken Rogoff, who along with his colleague Carmen Reinhart has been the best rune reader of the past few years, says that historically during financial crises, “to the extent that you act to slow the deep, sharp economic pain, you also slow the recovery.” As those cold-hearted Austrian-school economists would tell us, terrible pain results in quick adjustment. That’s not an argument for not acting; nobody wanted bread lines or riots after Lehman Brothers fell. In fact, it’s a mark of policy success—and the ability of central bankers to buffer Darwinian economic cycles—that today’s economy feels boringly sluggish rather than frightful.

Now is the moment to start making it more than that. Conservatives argue that the path to growth comes through slashing the deficit as well as red tape and taxes. That would give business money and the motivation to spend it. Businesses and consumers have gotten their balance sheets in order. The government should too. Then companies would have the confidence to invest.

Some cite Sweden as a model. Four years after a similar financial crisis began in 1992, it started slashing public debt, erasing its entire deficit by 1998. Sweden subsequently boomed. The difference, according to the McKinsey Global Institute, which has studied several decades of sovereign debt crises, is that Sweden was already growing strongly—3.5% annually—when it started rolling back public stimulus and focusing on debt reduction. Companies and consumers were ready to pick up the slack.

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That’s not yet so in the U.S. Companies facing economic uncertainty are unlikely to part with the $2 trillion under their mattresses regardless of debt or tax rates. While unemployment has ticked down, the average annual earnings growth of U.S. workers fell to a postwar low in October. You really can’t have a sustainable recovery in an economy that’s 70% fueled by consumer spending when 90% of the income gains since the recovery began have accrued to 1% of the population.

That’s why I think the key to really solving the growth puzzle is tackling inequality. It’s been labeled a social issue. But there is growing reason to think of it as an economic one. International Monetary Fund research shows that countries with bigger wealth gaps tend to have shorter periods of high growth and more volatile economies. That’s in part because they try to mask inequality by expanding consumer credit, which leads to debt bubbles and financial crises. (Sound familiar?) IMF policy wonks actually believe that reducing inequality is as important as, say, free trade in terms of fostering economic growth.

There are plenty of policy choices available—none of them of the Robin Hood variety—to reduce inequality now. Tax reform, including closing of investment loopholes for the rich, would be No. 1. Experts like Rogoff believe that “vast simplification” of the code would make it not only fairer to all taxpayers but also more business-friendly; indeed, a Harvard Business School study found that it’s the convoluted nature of the tax code, not tax rates, that sends business abroad. Also, before the government exits the housing business, a bit more support for mortgage restructuring in the worst-hit areas could help housing and the recovery; there’s still $250 billion worth of foreclosures in the pipeline.

Finally, as we navigate the fiscal cliff, we should think carefully before subtracting any discretionary spending for public education. College enrollment may now be more tied to parental income than aptitude. If we want to get beyond a 2% economy, we’ll have to ensure that more than just the 1% can succeed.

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25 comments
superlogi
superlogi

Four or five years?  What have you been smoking?  The fact is, we've juiced the economy by borrowing about 10% of GDP for the last 6 years and we're experiencing something under 2% GDP growth.  That's a dollar return for every five borrowed.  Just how much longer do you think we can keep that up?  Maybe you should ask the vaunted economist Paul Krugman who, apparently, thinks any amount of borrowing isn't too much.  Oh, and let's not be clear.  We were never in jeopardy of going into a depression.  That was nothing more than a campaign slogan.  In any case, if you want to give credit to someone for that piece of fiction, the guy's been in retirement for the past four years.

mkueber001
mkueber001

Rana, you state the following conventional Democratic wisdom, "There was plenty of talk during the campaign about the extent to which the Obama Administration’s fiscal stimulus and the Fed’s sustained money drops have helped or hurt the economy since 2008. Let’s be clear: it’s the reason we didn’t go into another Great Depression." A Republican friend recently pointed out to me that the Obama stimulus was adopted in March 2009 and the Great Recession officially ended in June of 2009, which wasn't enough time for the Obama stimulus to have any significant effect.  Thus, the stimulus wasn't needed to avoid another Great Depression.  The Republican argument makes sense to me; what is its flaw?

DeadLawff
DeadLawff

This is a very interesting article - I couldn't agree any more about the growth puzzle, while incredibly complex and requires many solutions, needs to be addressed by tackling inequality.  The credit to make us feel more equal cannot happen again (another very good point).

walstir
walstir

“IMF policy wonks actually believe that reducing inequality is as important as, say, free trade in terms of fostering economic growth.”

If Warren Buffet were to relocate from his hometown of Omaha, Nebraska (pop: 408,958 people) where he has lived since 1956, there would instantly be a massive decrease in income inequality in that city. Would that decrease necessarily foster the city’s economic growth?

JamesCorbett
JamesCorbett

This is the most seminal piece on the economy I've read.  Sweden, for example, has no debt, strong infrastructure, free education, free health care, and more billionaires and millionaires (as a percent of the population) than does the US.  Consumer economies MUST have  a strong middle class to drive spending.  When economic growth goes to the top 1% as it has in the US, recovery will be long and painful.

Benthere
Benthere

"Ironically, the stimulus is also a reason the recovery has been so slow and will continue to be for the next three to five years."

This is obviously written by someone who does not understand economics.  The stimulus did not cause the recovery to be slow.  The issue is that the level of stimulus was too low to generate a more vigorous recovery.  Also, financial recession recoveries have usually been slow because policy makers do not act aggressively enough, not because they "have" to be slow.  

cent-fan
cent-fan

So it sounds like John Boehner will only accept a complete restructuring of the tax code to negotiate the fiscal cliff... with six weeks to go in the year and a flock of lame ducks... with no doubt healthy cuts to corporations and the rich... and no more loopholes for the damned parasitic middle class (and that means new revenue "just like the President wants" but "no new taxes").  Yep, the House took the time machine through the primaries and the campaigns and just popped out of it yesterday.

ahandout
ahandout

Ahhhhhhh! You are the managing editor in charge of business and econ?  For what country?  Sweden.

Inequalities, the 1%, sending more kids to college to get a degree for a jobless economy, you sound like a social engineer for the Socialist Party.  Where are the incentives for business to grow or even stay in business? 

The reason that the top income earners have made gains is because they have a job, a business.  What is wrong with being successful?  Do you aspire to continue to be mediocre? 

Tinkering with socially engineering the economy lead to the lending practices that crashed the economy, sound familiar? 

Here's an idea:  Provide incentives for businesses to grow and hire workers, have a vibrant economy with a variety of jobs for a variety of skills (not everyone want to sit behind a desk), make real free trade treaties, and tax imports to make our products competitive if we have to.  China is not going to start a trade war; they have a billion people to feed. 

MrObvious
MrObvious

Excellent post and a good example of how other countries solved their deficit problem and what was the root cause of their success.

Galen
Galen

@ahandout  

 more stupid from a con!!

 you have no problem with tinkering to hand more wealth to the 2%, who by the way, do not create jobs. consumers and consumption do. you trickle effect is what is running down your leg.

nhautamaki
nhautamaki

@ahandout What the heck are you suggesting?  That government starts bribing businesses?  What, the 2 trillion they already made and stashed isn't enough, if only they have 3 or 4 trillion dollars in stashed profits they'll finally have enough incentive to trickle a bit down on us proles?

Ohiolib
Ohiolib

@ahandout  

Calm down crackpot. You're just ticked that a communist socialist fascist kenyan community organizer beat the most electable chump you guys could come up with. 

ahandout
ahandout

@nhautamaki @ahandout  Who is this imaginary "they"?  

It's a well known economic principle that whatever you incentivize, you get more of.  Maybe you should crack open a book.  Just sayin'.

ahandout
ahandout

@Ohiolib @ahandout  Yeah, you don't sound like a crackpot at all.  Shouldn't you be working in one of those Obamajobs in Ohio? 

nhautamaki
nhautamaki

@ahandout 

"they" are the business leaders in the private sector that have stashed 2 trillion dollars they are not spending or investing, as per the article.  Why aren't they spending it on new jobs or infrastructure?  Your magic word: incentive.  They have no incentive to do so because there is not enough money left in the middle class to make any investment in future profits worthwhile for any single individual corporation.  And there won't necessarily ever be either, unless government steps in.  It's not private business's job to invest in public infrastructure like roads, bridges, sewage, communication, power grid, etc; they are waiting for government to step in and do its job.  And when government does that, and hires skilled workers at a solid middle class wage to do so, businesses will once again have a middle class market to purchase their products and justify further investment in creating new jobs--but the cycle begins with government investment.  Until government steps in to do its job, businesses have no incentive to do anything but hang on to the 2 trillion dollars they've got stuffed under the mattress.

Benthere
Benthere

@ahandout @Diecash1 @bobell 

To the extent that Europe is intentionally following Keynsian economics, they are intentionally driving the shrinking of their economies and hurting millions of people .  Their stated reasons for their actions though, are totally at odds with Keynesian principles.  Austerity will bring growth!  However, the evidence is clearly to the contrary.  Krugman and others have been quite clear about what is going on in Europe, and you obviously have not been reading what they have been saying.  Before you criticize Krugman, you should at least be clear as to what he is saying.

ahandout
ahandout

@Diecash1 @ahandout @bobell  Paul Krugman is a liberal Keynesian.  Keynesian economics, that's how countries in Europe got into debt and are now brink of default.  I suppose that you haven't noticed.

"So long as people take their policy guidance from committedneo-Keynesian advocates like Paul Krugman, who continue to follow thesame socialist line set down a century ago by the likes of Hansen andCurrie, we shall make no progress on truly fixing the US economy."

 http://blogs.reuters.com/christopher-whalen/2011/07/05/paul-krugman-and-the-neo-keynesian-myth-of-full-employment/

Diecash1
Diecash1

@ahandout @bobell You're delirious, as usual.  Krugman has been precisely right about nearly everything since the Great Recession, including the effect austerity would have in Europe.  Didn't you and the rest of the jacka$$ right-wingers around here recommend precisely that for the U.S.?  Yeah, you did.  Given such evidence, you should save your opinions on economic matters as you have no credibility whatsoever.

MrObvious
MrObvious

@ahandout

Do you think well paying jobs just produce themselves because you wish it?

You apparently do. Righties think that if you lower taxes people will start hiring. Then by hiring more people it'll grow the economy. Never mind the secret sauce - called demand.

Why should someone hire people if there's no demand? Because they recieved a tax cut? What for - if I was a business leader and recieved a tax cut but didn't see demand I would just bank that money and wait until there is DEMAND.

How do you create demand? By making sure someone have the money to spend. If corporations ain't doing it (cause they don't see demand) you create a job so that a person have money to spend to increase demand.

Paul Krugman's ideas haven't worked. They are tried and tested failures. You can start with Europe.

First of all you see Paul Krugmans ideas at work every single day. Called our Military industrial complex. Guess why most people think that there will be a recession next year? Because of the sequestration. Why is that? Because it demands steep automatic cuts in Military spending. Now how come THAT will cause us to go into a recession  Because when the government don't spend that money buying Military equipment, the defense industry have to lay off workers.

THAT is the effect of the government hiring someone. 

And it DOES work. 

So why is our recovery so lackluster? Well first the recession hurt, but then states started laying off well paid Middle Class jobs at the same time our private sector started hiring lower paid jobs. So the effect is that while we have more people working again, they're not as well paid - so not only are we hurting on the revenue side, but states are hurting from loss of revenue, loss of the kind of work they need to get done and the economy is hurting from the loss of demand. Low paid jobs cannot possibly pick up that type of demand that we need from a solid middle class.

You can thank GOP policies for that; always rewarding companies to outsource well paid jobs and fighting tooth and nail for a better minimum wage. The result is that there's a vital lack of demand and small and middle sized businesses are hurting. Note that large corporations are not.

ahandout
ahandout

@bobell Do you think well paying jobs just produce themselves because you wish it? 

Sure the government should drop money from helicopters.  Why not.  

Paul Krugman's ideas haven't worked.  They are tried and tested failures.  You can start with Europe.

Diecash1
Diecash1

@bobell Stop using logic and reason in an attempt to enlighten someone so utterly ignorant about economics.  You'll only hurt his fee-fees.

@ahandout If the government doesn't create jobs, certainly a popular notion for you and your brethren, precisely how does it encourage hiring in the private sector when there is a distinct lack of demand?  Riddle me that.

bobell
bobell

@ahandout The way to incentivize work is to offer well-paying jobs. The way to offer well-paying jobs is to engage in economic activity. The way to engage in economic activity is to spend money. The way to spend money, if the private sector won't, is to have the government do it.  Private industry is sitting on two trillion dollars. They won't spend it because there's nothing to spend it on -- why produce more product when no one's got the money to buy it?

Try reading someone who isn't an Austrian-freshwater economist. Start with Paul Krugman.  Try doing it without preconceptions. You'll be amazed.

MrObvious
MrObvious

@ahandout

Note that the allegations of what Obama supposedly is, is a collection of the kind of nonsensical buzz words righties use. So if you think it's sounds crackpot, it's because righties such as yourself have thrown them around here.

You can be as bitter as you want - but get real.