Economic Growth Disappoints

The latest revision to the third quarter GDP numbers produced a disappointing report. While most analysts had been looking for growth to be about 3.0%, which would have meant another slight upward adjustment, the final tally was only 2.6% and thus quite a bit short of expectations. The hope had been that growth would be picking up as we head into 2011, and that the new stimulus hidden within the recent tax deal would then catapult us higher into the mid 3.% to 4% range. Now such a spurt looks much more difficult unless the fourth quarter comes in unexpectedly strong.

The second revision to the third quarter figures released last month had shown growth at 2.5%, and with some sectors of the economy performing better than expected – sales of autos especially – many people had stared to believe the economy was in much better shape. Indeed there were rumblings that too much more stimulus would only show up as inflation rather than as real growth. Such thoughts are now to be banished. The economy is growing, but it is nowhere near growing fast enough either to tackle unemployment quickly, or to raise inflationary concerns. Instead we appear to be still stuck in a sideways crawl, like a crab on the beach not going anywhere in particular.

Indeed the pessimists might get support from the numbers. Much of the jump in growth from the second quarter, which saw GDP rise only 1.7%, was due to factors such as a drop in imports and a rise in inventories, both of which can have very ambiguous causes. Imports typically rise when the US is growing quickly as demand for finished goods and raw materials takes off. That imports fell could be an early sign of renewed stagnation. Likewise the fact the inventories continued to rise can also be interpreted as a weak sign: perhaps businesses overestimated sales and will have to cut production in order to get sales to inventory ratios back in line.

Of course there are more optimistic interpretations too. Especially for inventories. During the recession firms cut back drastically on inventories as they reduced their sales forecasts and generally hunkered down to weather the storm. As the recovery gained steam the need to rebuild inventories re-asserted itself and we saw a long and steady climb back towards more normal levels. Sales forecasts were raised, albeit only slightly, and production rose accordingly.

Obviously the key will be the holiday selling season. Early indications are that it is fine but not great. Steady as she goes seems to be the way to characterize the state of the economy.

And therein lies our problem.

We need much more rapid growth to work off the huge slack that still hampers the employment market. The longer we go without such a burst of activity the worse the situation becomes for those workers who have been unemployed for a long time. Their skills and enthusiasm will ebb, and with a hostile Congress their chances of getting more help is receding. Unusually for the US we are now, apparently, facing a very European like sclerosis in our vaunted job market. Flexibility used to be the watchword during our business cycles, with rapid increases and decreases in unemployment. The last two recessions should have warned us that our job market was getting very “sticky”, by which I mean the decrease in jobs took longer to reach bottom, and the recovery took much longer to re-absorb the unemployed. This cycle has been even worse. It truth it has been awful, not just in its severity, but in its stubborn lack of improvement. This more Euro style cycle is unnerving for America where the Euro style safety net does not exist, and old fashioned puritanical attitudes toward the unemployed resurface very easily. This comparative weakness in our safety net programs was all well and good when we had a youthful and dominant economy. Clearly the economy has moved on. Unfortunately our political thinking has not. It may take a few years of suffering for us to realize that this was not just another cycle, but was the end of a long term decline that we now need to arrest and address.

Which leads me to this:

I have said it many times, but it bears repeating, healthy economies and healthy societies do not privilege one part over another for long. They seek and try to maintain balance. During the 1950’s and 1960’s the US managed to locate a mother lode of wealth by staying in such a balance. Profits, wages, productivity, and wealth moved in a harmonic trend together. Neither wages nor profits soared at the expense of the other. Higher wages fed sales which created higher profits and so it rolled on. After the Reagan illusion set in and the economy shifted towards debt based growth and short term profit gain at all costs, the balance was lost. Or rather it was deliberately thrown overboard. The new generation of managers and politicians, steeped in Friedman and Hayek, tossed away any notion of social cohesion whilst in the misguided thrall of free market dogma. The result has been the steady rise in inequality, profits reaching record levels while wages stagnate, and the substitution of debt for equity at both the household and business level as the cost of keeping decent growth in living standards became ever more difficult. Our post 1980’s leaders formed an educated elite who drove home the advantage their education wrought. The bulk of the rest were left way behind.

This asymmetry eventually eroded the economy’s ability to self generate wealth in a steady even stream. Instead it became susceptible to Minsky like financial cycles and thus inevitably to implode. Bank caused bubbles are the new norm. The rentiers cling to their privilege by offloading the cost of recovery to the taxpayers who are now underrepresented within the halls of power. To belabor the blame due Friedman and Hayek: we were indeed “free to choose”, but we were led along the “road to serfdom”. A populist reaction was inevitable, and the Tea Party seems to be its first manifestation. People will lash out even if they lash out in the wrong direction, as they have done this time.

Free markets just don’t work in complicated societies reliant upon complex production to meet its needs. The market needs to be augmented by strong government intervention to prevent rent seeking imbalances from creating an uncontrollable yaw. When we fell for the free market illusion we condemned ourselves to exactly the kind of cycle we are now suffering through. And it looks as if the denouement is years of unsatisfactory GDP growth and prolonged unemployment. We hurtled back in time to the pre-Keynesian world of classical economics and a highly bifurcated society. We embraced red blooded capitalism in an age when global reach and rapid technological advances exposed us as easy prey to those with capital or lower costs, and those in control of the vast bureaucracies able to move resources around at will to seek profit from that capital or those lower costs.

How many times during this cycle have we been told that we need to swallow unpleasant medicine in order that the “system” be saved? Did we ever ask in sufficient depth who this system benefitted? If the market is so magical how come the system broke? Should those who benefitted not pay for its repair? If there is one lesson that history should have taught the average citizen: there is nor “fair” in laissez faire. When we start to be told about rising tides lifting all boats we should question who is on the biggest boat. When we are told that something trickles down, we should question whether a trickle is enough. Yet we fell for the illusion, and soldiered on getting ever more into debt in order to stay afloat.

We shut our eyes to history. That’s never a good thing.