Commentary by Elliott Parker: Why hasn't the economy recovered?

A recession is fascinating, in a morbid sort of way, for an economist. But I must admit that I am really getting tired of this one, and would like to get back to considering other problems.

Real Gross Domestic Product grew at an average 3.6 percent annual rate in the decade before 2000, and 2.4 percent annually in the seven years after, well ahead of the 1 percent average annual rate of population growth. It began falling in the first quarter of 2008, and by the second quarter of 2009 it was down 5.1percent.

Technically, the recession has been over for two years already, though it doesn't feel like it. A recession is when the economy actually shrinks, followed by a trough and then a recovery. Since 2009, our GDP has grown steadily but slowly and has almost reached the level it was back at the end of 2007. Population has grown by 3 percent since 2007, however, so we are still really lagging behind.

For the last two years, average per-capita income increased, but not for the average person. Instead, most of the rising income has gone to the top 2 percent of the distribution, for people whose incomes come from capital gains and stock options. The unemployment rate has pulled back from its peak of 10.1 percent in the last months of 2009, but at 9.1 percent it still remains stubbornly high. Benefits have ended for many unemployed, and a significant number have simply withdrawn from the workforce, giving up, retiring early, or even going on disability to replace their incomes.

A recession caused by a financial crisis is simply different than most recessions; it is deeper and longer and harder to recover from. Immense damage was done by reckless lending behavior and homebuying driven by the foolish belief that prices would always go up, and that this time would be different.

Most Americans lost a large fraction of their net wealth, and that has long-term effects on their consumption spending. The balance sheets of most financial institutions were so badly damaged by the dramatic growth of nonperforming loans that banks are still very cautious about lending again. Banks are instead still holding huge piles of excess reserves, with over $1.6 trillion on deposit at the Federal Reserve alone. Firms don't hire when people aren't buying and banks aren't lending.

Before the recession began, private consumption and investment in new residential housing had reached record levels, and record shares of GDP. Our nation's total spending substantially exceeded what we produced. Americans stopped saving, and we chose to live beyond our means. We had to borrow from abroad to pay for what we bought. The federal government was doing it, too, running large deficits as it cut taxes and fought two wars, borrowing during good times instead of putting something aside for a rainy day.

Perhaps a recession was due to pull us back to living within our means. Unfortunately, as we cut our spending, our income fell - and not coincidentally, since the less we spent, the more people lost their jobs. It becomes harder to live within your means when your means fall too. But this also means that we can't recover back to the economy we had, since that was clearly unsustainable.

This global recession was largely "made in America," but the waves it caused elsewhere keep rippling back and drowning our meager efforts at restoring confidence. Adjusted for inflation, our exports have grown by 22 percent since the recovery began, and are now at the highest share of our GDP ever. This has helped, but it has not been enough to close the foreign trade deficit.

Faster economic recovery would require more purchases of the goods and services we can produce, but if domestic consumption is unlikely to return to its former unsustainable levels, if banks aren't lending enough to fuel private investment, and if growth in foreign exports is limited by problems abroad, why isn't the government increasing its purchases to take up the slack?

The federal government has significantly increased its spending, as many people have urged.

But where did that spending go? And why didn't it lead to a faster recovery?

National defense spending, which accounts for one-fifth of the federal budget, has grown faster than the economy over the last decade. In real terms this spending grew by an average rate of 4.6 percent from 2000 to 2007, and 3.7 percent since, though most of the latter increase happened during the so-called "surge" in Iraq in 2008, not during the recovery.

However, the biggest portion of the federal budget goes to social spending - mostly what economists call "transfers." For individuals, transfers are primarily social benefits like Social Security, Medicare, veterans' pensions and unemployment benefits. The federal government also helps state and local governments pay for these things, as well as for highways and other spending.

According to the Office of Management and Budget, federal spending on everything else makes up only 11 percent of the total budget. This spending has fallen significantly since the recession began, even without adjusting for inflation or population growth.

Furthermore, the overall increase in federal spending has been mostly offset by decreases in state and local government spending. Subtracting out social benefit transfers to individuals, and adjusting for inflation, total government purchases of goods and services have only risen by a total of 2.2 percent since the end of 2007 - less than half the rate of population growth over that period.

Thus, the growth in government spending has gone almost entirely into the pockets of those receiving federal benefits, not those who work for government or sell products to the government. As with the many tax cuts in the stimulus package, these transfers have only dampened the decline in consumer spending. Contrary to popular belief, the government has not actually been buying more goods and services, not overall, so how can it possibly make up for the decreased demand from the private sector?

Professor Elliott Parker is chairman of the Economics Department at the University of Nevada, Reno.


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