Digging out from the Great Recession: Prospects for Jobs and Economic Growth

Labor and Employment Relations AssociationPresidential Address

January 8, 2011

Eileen AppelbaumCenter for Economic and Policy Research

Digging out from the Great Recession• Where we are

• How did things go so wrong?• Experiment with laissez-faire capitalism • Collapse of the housing bubble• Financial meltdown

• Job market in crisis

• Inadequate policy response

• Government deficit • Short-term: Not a burden• Long-term: It’s health care costs

• Digging out

Worst Recession in More than 60 Years

Compared to previous recessions:

• GDP fell further

• Capacity utilization declined more

• Downturn lasted longer (Dec ’07 – June ’09)

• Payroll employment fell further

• Unemployment increased the most

• Global recession

Experiment with Laissez-Faire Capitalism

Deregulation of financial markets (Since 1980s)

• Innovative financial products: Derivatives, credit default swaps, etc.

• Lax regulatory oversight: Markets to discipline participants

• Relaxation of underwriting standards for mortgages

• Belief of economists in power of monetary policy to stabilize economy

• Greenspan, Bernanke, elite economists ignored warning signs

• Massive surge in house prices, rise in stock prices

• Catastrophic performance contradicts efficient markets thesis

Experiment with Laissez-Faire Capitalism

Deregulation of Labor Markets

• Push to make labor markets more ‘flexible’

• Trade agreements: Blue collar workers face global competition

• Lax enforcement of labor/employment law

• Unions weakened; more workers subject to ‘employment-at-will’

• Value of real minimum wage allowed to decline

• Power in wage setting shifted to employers

• Wages stagnated, inequality increased

Share of Total Income Going to Top 1 Percent of Households, 1913-2010

0%

5%

10%

15%

20%

25%

1910 1930 1950 1970 1990 2010

Perc

en

t of

all

inco

me

Source: Pickety and Saez (2009), income with capital gains fully excluded

Debt-Driven GrowthEconomic growth: Debt driven, rather than wage driven

• Debt of average American household:• 1990: 83% of income• 2000: 92% of income• 2007: 130% of income

• 2005-7: Savings out of disposable income fell to less than 1%

What made this possible?• Clinton/Bush era housing bubble • Weak regulation of financial market players• Securitization of mortgages • Homeowners refinanced, took equity out via cash or HELOC• Assumption: House prices would never fall

Stagnant Real Wages but Increasing Consumption, 2000-2010

80

85

90

95

100

105

110

115

120

125

130

2000Q1 2003Q1 2006Q1 2009Q1

2000

Q1

= 1

00

Personal C onsumption Expenditures

Median Usual Weekly Earnings

Source: Bureau of Labor S tatistics and Bureau of Economic Analysis

Housing BubblePhase I: 1996-2002

• Stock market bubble fueled demand for bigger/better homes• Stock market bubble collapsed, 2000-02: Real estate seen as safe I• 30% increase in inflation-adjusted house prices by 2006

Phase II: 2002-2006• Low interest rates: 30 yr mortgage rate fell to 5.25% in 2003• Lax underwriting, financial ‘innovation’• House prices increased a further 32% from 4thQ-2002 to 4thQ-2006• Run-up in real house prices 1996-2006: $8 trillion in bubble wealth

• Wealth effect added $400-$500 billion a year to consumption• Savings rate fell to less than 1% in 2005-2007

• Starts peaked at 2.1 million in 2005, 50% above pre-bubble

Collapse of the Housing Bubble

House prices peaked in 2006, then fell substantially• 2006-08: Housing wealth declined $6.4 trillion

• Decline in consumption (wealth effect in reverse)• Demand for houses: Residential construction collapsed• Economy went into recession: December 2007

• 2009: Housing wealth declined further $1 trillion

• 2010: Some experts predicting further drop of $1.7 trillion

Collapse => Recession, turmoil in financial markets

Financial Market Melt Down

In 2008, many homeowners ‘underwater’

• Delinquency rates and foreclosures rose sharply

• Value of MBS and related derivatives dropped precipitously

• Market for these securities collapsed

• Insurers (e.g., AIG) could not make good on credit default swaps

• Many instruments, institutions exposed to losses • Investors had little confidence in financial instruments

• Led to credit squeeze that hit financial markets in 2008• Bankruptcy of Bear Stearns, liquidation of Lehman Brothers• Near death experience for AIG, Goldman Sachs

Job Market Crisis

Worst Jobs Crisis Since Great Depression

• Unemployment hit 10% Oct. 2009, still very high• Dec. 2010 post-depression record: 20 months > 9%

• Unemployment + sub-employment = 25 million workers

• 40% (>6 million) jobless more than 26 weeks

• Lack of demand, not structural/skills mismatch

• Nearly 4 million missing workers – dropped out of labor force

• Job creation should be top priority – why the focus on the deficit?

Sharp Decline in Payroll Jobs

J ob Loss in Five Most Recent Recessions as Percent of Peak Employment

-7

-6

-5

-4

-3

-2

-1

0

1

2

0 6 12 18 24 30 36 42

Months since start of recession

Pe

rce

nt

cha

ng

e f

rom

sta

rt o

f re

cess

ion

J ob Loss in Five Most Recent Recessions as Percent of Peak Employment

-7

-6

-5

-4

-3

-2

-1

0

1

2

0 6 12 18 24 30 36 42

Months since start of recession

Pe

rce

nt

cha

ng

e f

rom

sta

rt o

f re

cess

ion

Source: Bureau of Labor Statistics

1980

1973-1975

1981-1983

1990-1993

2001-2005

2007-present

Millions of Workers Left Labor Force

Employment- to-Population Ratio, 2000-2010

54

56

58

60

62

64

66

J an2000

J an2001

J an2002

J an2003

J an2004

J an2005

J an2006

J an2007

J an2008

J an2009

J an2010

Pe

rce

nt

Source: Bureau of Labor S tatistics, C onsumer Population Survey

Inadequate Policy Response

By the fall of 2008, when Barack Obama won election:• HHs had lost ~ $12 trillion of housing bubble, stock market wealth• => Drop in consumption ~ $600 billion a year• Residential construction falling at ~$450 billion a year• Non-residential construction falling at ~ $200 billion annual rate• Private sector demand down ~ $1.2 trillion (about 9% of GDP)

Policy response: early but inadequate• Bush TARP – bailed out banks, but no economic stimulus• Feb. 2009, stimulus $784 billion over 2 years on party line vote

• Small relative to size of hole – in part, to get through Congress• Also, econ advisers missed bubble, underestimated severity• Over-promised results: public disappointed, confused

What About the Deficit? (Short Run)

Deficit due to recession and fall in tax revenues -- There has been no explosive growth in spending

• Non-interest spending: 19.8% of GDP in 1980, 21.1% in 2011• Compare with ‘austere’ Germany; record high UK public sector deficit and net

borrowing in Nov. – why both are still growing• Tax revenue as % of GDP: >18% ave. 1970-2007, 14.8 % in 2009

America is not ‘going broke’• Unlike Ireland or Greece, US owes debts in currency it controls: $$• Will always be able to pay interest on Treasury debt

Disinflation, not inflation, and low interest rates

Federal Tax Receipts as Share of GDP

14

15

16

17

18

19

20

21

22

1981q1 1984q1 1987q1 1990q1 1993q1 1996q1 1999q1 2002q1 2005q1 2008q1

Pe

rce

nt

S ource: Bureau of Economic Analysis, National I ncome and Product Accounts

Myth: German ‘Austerity’ vs. US ‘Profligacy’

Change in Government Expenditures, 2007 - 2010

96

98

100

102

104

106

108

Q4 Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4 Q1 Q2 Q3

2007 2008 2008 2008 2008 2009 2009 2009 2009 2010 2010 2010

2007

Q4

= 1

00

Germany

United States

Source: OECD

What About the Deficit? (Short Run)

Austerity is not the solution

• Premature fiscal consolidation will slow growth, reduce tax revenues

• GOP already calling for spending cuts to ‘pay for’ tax compromise

• Won’t achieve hoped for reduction in deficit

During high unemployment, deficit need not be a burden

• Not inflationary when there are unemployed resources

• Fed can buy Treasury debt – return interest to Treasury

• Later, can raise bank reserves to unwind this policy

What About the Deficit? (Long Run)

Long-term structural deficit (explodes after 2020):

• Driven almost entirely by explosion in per capita health care cost• Government programs cover more than half of US health care costs

• US already pays twice as much as other wealthy countries with same or longer life expectancy – expected to rise further

• With per capita costs similar to other wealthy nations, US would have budget surplus, not deficit

• Note that Social Security does not contribute to the deficit• By law, cannot pay out more than it has on hand

The Benefits of Controlling Health Care Costs

Projected U.S. Budget Deficit

-20

-10

0

10

20

30

40

50

1963 1973 1983 1993 2003 2013 2023 2033 2043 2053 2063 2073 2083

Pe

rce

nt

of

GD

P

S ource: Analysis of C ongressional Budget Office and World Bank data

U.S .

C anada

Germany

UK

Norway

France

Close Deficit w/o Painful Austerity Measures

Cut military expenditures for fruitless wars, unnecessary arms

Eliminate corporate welfare• Allow govt. to negotiate with drug companies on prices it pays• Stop subsidies for oil and gas exploration, production• Eliminate farm subsidies to big agro-business

Reform tax code• Enact financial transactions tax to discourage excessive speculation• Tax dividends, capital gains, ‘carried interest’ as ordinary income• Raise taxes on top 1%

The “deficit-reduction agenda is an attempt to weaken social protections, reduce the progressivity of the tax system, and shrink the role and size of government …” Joseph Stiglitz

Digging OutImmediate policies with minimal impact on the deficit

• Right to Rent: Provide real assistance on home foreclosures

• Work sharing: Prevent layoffs, retain workers, preserve skills

• Card check, first contract arbitration: Make it easier to form unions

• Minimum of 7 paid sick days a year: So workers don’t lose their jobs if they or a child gets the flu

• National FML insurance – employee-paid: To provide income and improve job retention

• Raise minimum wage and index to half the median wage

• Require bailed out banks to use funds Fed now provides at near 0% interest to lend to credit-worthy small businesses on favorable terms

Worksharing => Smaller Rise in UnemploymentChange in Unemployment Rate in Countries with and without Worksharing, 2007-2010

0.80.9

1.42.12.22.42.52.62.6

3.63.8

5.18.6

10.8-1.1

0.50.60.6

0.911.1

1.7

-2 0 2 4 6 8 10 12

NorwayAustralia

LuxembourgFinland

C anada Portugal

United KingdomI taly

SwedenNew Zealand

DenmarkUnited States

I relandSpain

GermanyAustria

Belgium Korea

NetherlandsSwitzerland

J apan France

Percentage PointsSource: OEC D

WorksharingNon-worksharing

Digging Out

Returning financial sector to pre-crisis profitability did not translate into robust growth and jobs

Economy needs more stimulus, done well• Government spending has to fill the gap in private demand

• HHs need to pay down debts and they are –> Can’t increase spending

• Maximum bang for the buck:• Extended UI benefits, increased food stamps

• Refundable tax credits for low and middle income households

• Invest in America’s future (now, while interest rates are low) –> High return public I increases deficit in short run, reduces it in long run

Conclusion

Short run:• Choice is simple – more stimulus or persistent high unemployment• Recession, financial crisis due to incompetent economic management• Appears that workers and their families will be forced to suffer for years into

future because of continued mismanagement

Long run:• Great recession, financial crisis exposed downsides of US model• Debt-financed consumption and economic growth are unsustainable• Not a substitute for wage–led growth (in line with productivity growth)