The US Recovery – Some Strengths & Weaknesses

By Bill Watkins, Ph.D
Edited by Gary Wartik
March 10, 2014

Every year since the Lehman Brothers’ collapse, we’ve had periods where GDP growth picks up a bit.  Every time this happens, we hear analysts and policy people declare that the recovery is finally gaining steam.  Every time disappointment follows.

One problem is that some analysts mistake normal volatility for a change in trend.  We have advice for these analysts, advice that will help them avoid embarrassing themselves anymore than they already have:  Look for three consecutive quarters of 3.5 percent real GDP growth before declaring a robust recovery.  Before that critical third quarter, express cautious optimism.  Even then, you could be premature.

Analysts often neglect the analysis of fundamentals, and that’s a problem.  Instead of looking at the forces driving economic activity, they often look at charts, and many times these charts represent such a high level of aggregation that they contain little useful information.

This was always going to be a long slow recovery.  A huge reallocation of real estate assets had to take place (see the real estate essay) and a huge amount of wealth was lost.  You don’t recover from those types of shocks quickly.

Most of the real estate reallocation has occurred.  Total wealth has more than recovered, but the distributional impacts are still slowing growth.  Real estate wealth has not fully recovered, and those whose assets are concentrated in real estate still have troubled balance sheets.  These include much of the middle class, and especially small business owners.

Perhaps more importantly from jobs perspective, small business owners have a much higher concentration of wealth in real estate than the typical American.  Over 90 percent of small business owners are home owners, and more than 50 percent own more than one piece of real estate.  Their still-over-leveraged balance sheet is slowing job growth.

That’s not all of our problems though.  Government has been part of the problem.  Governments have done everything they can to slow the transfer of real estate, deepening the recession and prolonging recovery.

Governments compounded the problem of job creation by regulation that provides perverse incentives for job creation or insurmountable barriers to expansion.  The Affordable Healthcare Act is an example of the former, while environmental regulation is probably the best example (of a long list) of the latter.

We also face serious challenges in our financial sector.  It was ravished by the recession.  For example, there have been 71,000 bank failures in the past six years.

Our financial sector is less competitive than it was prior to the recession, and the perverse incentive of Too-Big-To-Fail are still with us.  We will have another financial crisis, and because of increased concentration of bank assets in the largest ten or so banks, it could be much more costly than the most recent crisis.

We also believe that the concentration of banking assets is impairing small business’s ability to access capital necessary for job creation.  This is part of a long-term trend.  The United States now has about half the number of banks that is had at the beginning of the 1990s.  Because of population growth, the ratio of banks to population has seen a far steeper decline.  We note with approval the small increase in 2013:

On top of the problems created by government and the challenges in the financial sector, demographics are slowing our growth.  The Federal Reserve estimates that about a third of the decline in our workforce is a result of retiring Baby Boomers.

Finally, technology may be causing unemployment.

That’s a strange thing for an economist to say.  People have worried about technology generating unemployment since the beginning of the industrial revolution, but the industrial expansion since the industrial revolution has been accompanied by explosive job and population growth.

That said, there have been disruptions as people adapted to a rapidly changing environment.  A displaced worker’s skill set may not match job demand.  The more rapidly the technology is changing, the more people who will find themselves in these circumstances.

This idea is getting some serious consideration, led by Arnold Kling.  He’s given it the name Patterns of Sustainable Specialization and Trade (PSST).  Kling argues persuasively that the depression was a time of very rapid technological change, and that change contributed to persistent high unemployment.  George Orwell’s Down and Out in Paris and London provides a moving vignette of the challenges the displaced faced and the human costs of the displacement.

If PSST is a significant contributor to our current high unemployment, the policy prescriptions are very different than those of Keynesian models, Austrian models, or Classical models.  We provide policy recommendations in our US Forecast essay.

Given all these factors, we don’t expect to be declaring a robust economy this year.

For more information, visit Vision Economics.


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