international analysis and commentary

Too early to celebrate economic Spring


Last month, the US economy added 227,000 jobs, and data from the two previous months were revised upwards by 60,000 more jobs.  This marked two full years of job growth, in which 3.5 million jobs were added overall.  New housing construction is finally beginning to pick up, industrial production is improving, and unemployment claims are at their lowest level in four years.  This may look like recovery Winter followed by economic Spring.  We’re back!

Let’s settle down.  Unfortunately, there are ample reasons to restrain your enthusiasm.  First, this level of growth is fine for a full-employment economy, but if we’re going to get back to pre-recession unemployment levels, normal growth isn’t enough: we need catch-up growth.  Between the 8.7 million jobs the economy lost during the downturn and the 4.7 million it needed to create to keep up with population growth, even with the recent job gains the United States still faces a deficit of 10 million jobs.  And it doesn’t get any easier: we need to add roughly 125,000 jobs each month just to keep up with population growth, so only the job gains above that amount move the economy toward recovery.  Even if the economy proves able to sustain recent rates of job growth, it will still take about five years before the labor market fully recovers.

Of course, sixty straight months of solid job growth would also be totally unprecedented: in the post-WWII era, the economy has never added jobs for more than 48 consecutive months.  More likely, the economy will fall into another recession before then, with the very real possibility that the economy will never recover its pre-recession employment levels.

The second reason that we shouldn’t get too excited is that there is a certain non-mechanical aspect to economic recovery, in which “animal spirits” and confidence (or lack thereof) can take over. 

A significant element of a recession is something known as momentum.  Recessions are characterized by a drop in demand followed by a fall in supply. Consumer confidence tumbles, and people spend less money. This causes businesses to lose sales revenue, forcing them to cut hours and possibly lay off workers. This, in turn, reduces worker income and creates a climate of economic insecurity, causing consumers to spend even less, frightening businesses, threatening workforce and equipment investments, and so on.  In other words, consumers and businesses react to each other, matching one another’s retrenchment with even more retrenchment.  This is what gives an economy downward momentum in the midst of an economic collapse.

Once that collapse is over, a new equilibrium emerges – one of lower spending, lower investment, and deleveraging.  This is where the economy found itself in 2009.  And, for a while, it looked like we were stuck there.

Thankfully, the US economy is now emerging from its doldrums.  But, like with a recession, a recovery also needs momentum.  It needs businesses to be confident in their cash balances so that they borrow and invest; it needs consumers to start opening up their wallets.  And, most importantly, it needs each side of the equation to believe that the other will not abandon its new confidence in the face of some perceived danger.

Unfortunately, there are still quite a few potential dangers out there.  Greece’s deep recession threatens its ability to pay even the written-down value of its debt, and Europe’s “rescue fatigue” suggests that another bailout will not be available if needed.  Gas prices could rise precipitously, perhaps driven by instability in the Middle East or even by a spike in automobile use or increased speculation. Apartment rental prices could continue to rise, hitting lower-income households that are already struggling to make ends meet.

Another danger could even be of our own making.  Every Republican presidential candidate is proposing a level of immediate austerity that, if enacted, would significantly damage the economy.  Furthermore, on January 1, 2013, various deadlines promise the simultaneous expiration of unemployment benefits, of the payroll tax holiday, and of the Bush tax cuts, as well as the triggering of $1.2 trillion in automatic spending cuts. Should all this come to pass, the total fiscal contraction will amount to 3.5% of GDP.

Also, it is possible that the economy hasn’t even been growing as fast as we think.  The economic data upon which we are basing our confidence is mostly preliminary, and often inaccurate. Sometimes, indeed, economic green shoots turn out to be illusory.

As former Defense Secretary Donald Rumsfeld would say, there are a lot of known unknowns, and there are more unknown unknowns.  So far in this economic downturn, few have gotten rich betting on optimism.  Now, many are ready to admit, it does feel like the economy has hit an inflection point.  But we’ve been wrong before.