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Businesses Gird for Economic Depression

Prof. Peter Morici - 4/8/2009

The economy is shifting to permanently lower levels of production and employment, as the recession nears a depression.

Unemployment reached 8.5% in March. Adding in discouraged adults who have left the labor force and part-time workers who would prefer to work full time, the real unemployment rate is approaching 17%.

Simply, investors and employers lack confidence in the overall likely effects of Treasury Secretary Geithner's plans to stabilize banks and President Obama's stimulus package and budget proposals.

Lacking confidence that the demand for what Americans make and sell will recover significantly, anytime soon, businesses are girding for a long siege -- slashing employment and dividends and others hunkering down. They are preparing for a depression and the eclipse of American leadership.

The economy has shed 5.1 million jobs since December 2007, as the full weight of the banking crisis and trade deficit on oil and with China punish employment in autos, other manufacturing, construction and the broader economy. This drives down employment, wages and consumer spending and is creating a negative feedback cycle that threatens to cast the U.S. economy into something akin to Japan's lost decade or worse.

A Permanent Contraction and Double Digit Unemployment

The economy contracted at about a 6.3% annual rate in the fourth quarter of 2008, and will contract further through most of 2009. The huge stimulus package will lift GDP a few percentage points in 2010 and 2011, but it will likely not prove enough to halt contraction over all. Even if the economy grows for a time, thanks to stimulus spending, it will fall back into recession. The stimulus package will add about 2 million to 2.5 million jobs, but that will only slow the pace of job losses. Worse, those jobs will only be temporary and unemployment will shoot past 10% once the effects of stimulus spending wears off in 2012, if not sooner.

Increasingly, the economic slowdown looks more like a depression than a recession. Federal Reserve interest rate cuts and stimulus spending and tax rebates shorten recessions and ease their impact. However, those policies will not end the current slump, because it is grounded in fundamental structural dysfunctions in U.S. banking, energy and trade policies.

Employers in high tech, retailing, manufacturing, publishing and elsewhere are not temporarily furloughing workers. They are restructuring employment downward, permanently, for what they expect to be smaller markets for their products for several years.

Without systemic reforms, the more than 6 million jobs lost in 2008 and 2009 will not be regained for many years. The crisis requires quick and bold action, and it requires more than a politically conceived stimulus package. It also compels radical changes in how Washington regulates banks and fosters international competition and wealth creation.

Unfortunately, the stimulus package is poorly structured and will prove too expensive for the jobs it creates for two years and then again disappear. The banking and trade policies President Obama is pursuing will drive the U.S. economy deeper in debt to Middle East oil exporters, China and other foreign creditors, throw the economy deeper into recession and destroy as many as 10 million jobs before the calamity has completely run its course by the middle of the next decade.

The Face of a Modern Depression

In the 1930s, the economy suffered three false recoveries only to fall back into depression, because New Deal policies worsened structural problems that pulled the economy down in the first place. For example, the New Deal proliferated monopoly pricing, extended the life of undersized farms, raised structural savings rates, and created a system of home lending too dependent on federally sponsored banks -- a system that ultimately contributed to the current crisis.

World War II and the Vietnam War gave the U.S. economy reprieves from repeated downturns, but President Truman endured two recessions, President Eisenhower, two recessions, Kennedy, one recession and Nixon, two recessions. Then surging oil prices created the Great Inflation. Only when President Carter began deregulation of the economy with the airlines, and Presidents Reagan, Bush and Clinton continued this process did the economy enjoy the Great Moderation -- an unprecedented, sustained period of growth with fewer recessions and less inflation.

During the administration of George W. Bush, Bush ignored the abuse of free markets -- by the banks, domestically, and China, internationally through currency manipulation, high tariffs on imports and export subsidies.

Now Obama is repeating those mistakes by not altering approaches to banking reform and trade and appears poised to repeat the blunders of Roosevelt by reregulating the economy and pushing out the frontiers of the state.

The U.S. economy is built on industry and innovation, and doubling the Department of Education or beefing up municipal bureaucracies does little to expand manufacturing or R&D. The stimulus package is too weighed down with political baggage that will not boost employment or create private sector jobs.

Rather, virtually all the jobs the stimulus package will create will not be permanent, and those that are permanent will overwhelmingly be in government.