On The Economy -- A Recovery Built On Quicksand

Dec. 21, 2004
U.S. mired in sluggish growth.

It is normal for an economic recovery to pause a year or two after the upturn has started. In the initial phase of the expansion, inventories are rebuilt, and consumers and businesses catch up on purchases they postponed during the recession. The improvement in economic activity is accompanied by a rise in interest rates as the demand for credit rises and the monetary authorities nudge interest rates back toward equilibrium levels. Usually this pause is no cause for alarm, and in previous recoveries has often been called "The Pause that Refreshes." This time, it's hard to see much refreshing going on. After robust growth in the latter half of 2003 and early 2004, the U.S. economy has slowed down again: Real growth has fallen to 3%; retail sales have declined and employment gains have stalled out. Perhaps these declines are temporary -- particularly as they have been magnified by record high (nominal) oil prices -- and the economy will return to 4% growth as soon as oil prices recede to normal levels, generally considered these days to be about $30 a barrel. But don't count on it. Three months ago I believed the remainder of 2004 would be strong, followed by below-average growth starting in 2005. The sharp slowdown was a surprise to most economists, as was the surge in gasoline prices. And the fact that the energy-driven slowdown started earlier than anticipated certainly doesn't mean that the economy will bounce back to its previous strength once this impediment is removed. The major problem all along has been that consumers are living on borrowing time, spending more than they earn, in spite of the Bush tax cuts. Usually when tax rates are cut, the personal saving rate rises. However, in spite of the reductions in both 2001 and 2003, the reported personal saving rate is no higher than it was before these cuts were implemented. That does indeed suggest that the tax cuts did stimulate the economy and boost consumer spending, but as they are withdrawn, I do not see any stimulus replacing them. Interest rates invariably decline sharply during recessions and rise once the recovery gets underway, so in that sense the pattern this time is similar. The main difference is the unprecedented degree to which the increase in home equity has been monetized, fueled by a surprisingly large jump in housing prices since the onset of the recession. Many older people have been making ends meet by using reverse mortgages, a new development relative to previous recoveries. Also, some consumers have been raiding their retirement accounts, which did not occur in previous upturns either. Finally, and most important, real wages continue to decline, and payroll employment gains have almost halted again. Total employment measured by the household survey continues to post respectable gains; preliminary data show this series up 1.1 million for the three months ending in July, compared to only 300,000 for payroll employment. However, as workers continue to be reclassified from employees to self-employed, their average wage declines, and in many cases their fringe benefits disappear completely. Recovery from recession also got off to a slow start in the 1990s, with no gain in real wages for the first three years. However, that situation then dramatically improved, with real wages rising an average of 2% per year in the latter half of the decade. That won't happen again because of the increased pressure from foreign employees, and the continuing switch of workers to self-employed status so employers can avoid those double-digit gains in health-care costs. I think there will be some improvement in the economy when oil prices do return to normal levels. But it will be short-lived. Over the next several years, look for sluggish growth throughout the U.S. economy. Michael K. Evans is chief economist for American Economics Group, Washington, D.C., and president of the Evans Group, an economics consulting firm in Boca Raton, Fla.

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