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Thursday, July 30, 2009

Daniel Gross: Recession is Over, Recovery's Problematic

Daniel Gross in Newsweek:

In Westport, Mass., about 60 miles southwest of Boston, traffic crawls along Route 6 as drivers make their way to the nearby Atlantic beaches like Horseneck or Baker's. A 10-worker crew pouring and raking asphalt onto the road slows their progress. It's the kind of small annoyance drivers nationwide face each summer. It's also one small manifestation of President Barack Obama's ambitious strategy for jump-starting the economy.

In April, the P.J. Keating Co., a construction firm based in Lunenburg, Mass., bid on about a dozen stimulus projects funded through the U.S. Transportation Department. It won two contracts, including this $4.06 million job, rescuing what would have been a dismal year for P.J. Keating, says David Baker, 36, a manager of construction operations. As business dwindled over the past two years, the firm laid off about a dozen people. We definitely would have been faced with another half-dozen layoffs had we not gotten these stimulus projects, Baker says. Instead, the company kept all its remaining 300 employees, and hired five new ones. Ordinarily, a few -government-funded jobs, like traffic on Route 6, wouldn't be noteworthy. But the tableau neatly encapsulates the promise—and pitfalls—of an economy at an inflection point.

The Great Recession, which rolled over our financial lives like one of P.J. Keating's giant pavers, is most likely over. Home sales, while still far below the levels of a year ago, have risen for three straight months—a first since 2004. The stock market has rallied 44 percent since March, thanks to renewed optimism and improving earnings from big companies like Goldman Sachs and Apple. In June, seven of the 10 indicators in the Conference Board Leading Economic Index pointed upward, including manufacturing hours worked and unemployment claims. Macroeconomic Advisers, the St. Louis–based consulting firm, says the economy is expanding at a 2.5 percent annual rate in the current quarter. Economic activity will increase slightly over the remainder of 2009, Federal Reserve chairman Ben Bernanke told Congress.

Irrational exuberance, it's not. But even stagnation would be an improvement over recent history. The U.S. economy shrank at nearly a 6 percent annualized rate between September 2008 and March 2009, a shocking slowdown that pitched the global economy into recession for the first time since World War II. This looks an awful lot like the beginning of a second Great Depression, Nobel laureate Paul Krugman said in January. Catastrophe may have been averted. But when economists proclaim a recession over, they're celebrating a technicality: they mean economic output has stopped contracting. And while that is good news, you might wait a while before adding Judy Garland's rendition of Happy Days Are Here Again to your iPod. GDP growth alone can't feed a family, or pay a mortgage. Cursed with a high national debt load and blessed with a dynamic, growing workforce, the U.S. economy needs annual growth of at least 1.5 percent just to feel like we're standing still.

Worse, the data point that means the most to our psychological well-being—unemployment—is likely to keep climbing. The loss of 6.5 million jobs since December 2007 has spurred the sharpest rise in the unemployment rate since the 1930s. As manufacturing jobs move overseas and companies struggle to further reduce costs, unemployment—which stands at 9.5 percent—is likely to rise above 10 percent. There's a difference between having an expansion and an economy that has recovered, says Lawrence Summers, Obama's chief economic adviser.

Having survived a near-death economic experience, Americans now need to focus on surviving what's likely to be a pokey, painful recovery. "I see 1 percent growth in the economy in the next few years," says New York University economist Nouriel Roubini. "It's going to feel like a recession, even when it ends." Shifting our unwieldy $14 trillion economy from rapid reverse into neutral took heroic efforts from the Federal Reserve, the Treasury Department (in two administrations), two sessions of Congress, and, of course, the taxpayers. But the greater challenge may be getting the economy to start growing at a pace that creates jobs, boosts incomes, and raises corporate profits—all without triggering inflation.

A year ago, NEWSWEEK dubbed this a new kind of recession—one caused by turmoil in housing and finance rather than manufacturing or weak consumer spending. Now that it's over, we'll need a new kind of recovery. For 60 years, policymakers have relied on a series of simple tools for combating slowdowns and promoting growth: the Fed cuts interest rates, government slashes taxes, and a deregulated Wall Street provides easy money. All of which spurs debt-fueled consumption and the movement of goods and services around the globe.

No more. The Fed literally can't cut interest rates further—the overnight interest rate it controls is at zero. Given the deficits and Democratic control of Washington, the prospect of broad-based tax cuts are slim. Americans are still stuffing cash under the mattress. The last several recoveries were not sustained because they were based on bubbles, they were led by consumption, and they enhanced inequality, says Summers. The president's emphasis is on having a different kind of expansion.

The Obama administration's strategy rests on what some might call industrial policy or excessive government intervention—or even creeping socialism. I call it the smart economy. It means eschewing the blunt economic instruments we've always used and focusing resources and rhetoric on strategic sectors: renewable energy/green technology, infrastructure, broadband, and health care. It means making investments to run vital systems more intelligently and efficiently, thus creating a new infrastructure on which the private sector can work its magic. This philosophy, legislated in the $787 billion American Recovery and Reinvestment Act, holds that a mixture of targeted investments, tax credits, subsidies, reforms, and direct purchases can preserve or create jobs in the short term, improve America's economic competitiveness in the long term, and catalyze private-sector investment.

It's too soon to judge whether this enormous fiscal and political gamble will work. But as was the case the last time the financial sector destroyed itself—the early 1930s—it will be up to Washington to lead the way. We're witnessing an immense and aggressive substitution of public capital for private capital—and it is probably essential to our recovery. But the best-laid plans of Ivy League academics and charismatic young presidents frequently go awry (see: Vietnam). The stimulus package will work its way into the economy very slowly and, by itself, isn't nearly large enough to make up for all the wealth and jobs lost in the past two years. And there's great uncertainty as to how one of the most crucial components of the smart economy—health care—will be affected.

Those on the right say the Obama plan can't work simply because it's directed by government. (Every Republican in the House voted against the stimulus plan.) But even some on the left say it's aimed disproportionately at industry. In an economy in which consumers account for 70 percent of activity, what we need is more demand for goods and services, says Lawrence Mishel, president of the Washington, D.C.–based Economic Policy Institute. The missing pillar in Obama's articulation is really making sure that people's wages rise in tandem with productivity. Critics and allies alike fret about the pace of aid.

In his first hundred days, Franklin D. Roosevelt said he wanted 250,000 young men working in the forests for a dollar a day. Despite the howls of organized labor, a quarter of a million men were toiling in the Civilian Conservation Corps by the summer of 1933. They planted 3 billion trees, built 800 state parks, and saved the nation's topsoil. Larger public-works programs like the Civil Works Administration swiftly put millions of people to work erecting bridges and building dams.

Things aren't going quite as swiftly in New Deal 2.0. So far, only a fraction of the stimulus funding has entered the economy via tax cuts ($43 billion), and another chunk via aid to state and local governments ($64 billion). Much of that, however, was used to avert cuts rather than to create jobs. New York City, for example, was able to avoid laying off 14,000 teachers. And because the contracting process is more complicated than it was in the 1930s, the investment component will take more time. So far, only about $120 billion in new spending has been promised to specific programs. Using a rough guide that $92,000 of government spending creates a job, the White House assumes the stimulus will preserve or create 1.5 million jobs by the fourth quarter of 2009 and another 3.5 million by the fourth quarter of next year. But the White House says less than 10 percent of the employment impact from the stimulus will take place during 2009.

Several months pass before money from Washington arrives in paychecks in places like Westport, Mass. The Department of Transportation, which received $26.6 billion for highway projects, has approved 5,777 projects and promised $16.9 billion in spending. It generally takes six to eight weeks to get a project advertised and approved, and then a notice to start, says Joel Szabat, deputy assistant secretary for transportation policy. By the end of May, transportation projects had already directly created between 6,000 and 7,000 jobs. That's encouraging, but still a drop in the bucket—especially given the demand for work. In March, Lew Wood, superintendent of Amtrak's maintenance facility in Bear, Dela., received the go-ahead to hire 55 workers to help carry out a $58.5 million stimulus-funded project to repair 60 passenger rail cars. When we advertised the 55 jobs, we got 6,000 applicants, many of whom were former General Motors and Chrysler employees, Wood says.

The benefits of resurfacing roads and improving train service—fixing existing infrastructure and stimulating existing industries—are obvious and easy to gauge. But a significant chunk of the smart-economy program entails efforts to create new commercial infrastructure and new industries, which are more abstract and whose success is difficult to measure. That's especially true for the alternative-energy and clean-technology sectors, which received lots of goodies in the stimulus package: a $6 billion loan-guarantee program for alternative-energy investments, a $4.5 billion federal green-building-conversion effort, $5 billion in funds to weatherize low-income homes, and cash to promote smart-grid technologies.

Anthony Costa, acting commissioner of the General Service Administration's Public Buildings Service, says his agency has awarded 80 projects worth $375 million (out of a total of $5.5 billion granted in the stimulus bill) to upgrade federal buildings. The Blue-Green Alliance, a joint venture of unions and environmentalists, says 850,000 manufacturing jobs in existing plants could be converted to green jobs—building new products with the same equipment and employing skills of current workers. New Flyer, a Canada-based company that makes hybrid buses in St. Cloud, Minn., has received $213 million in orders for new hybrid buses from agencies in Philadelphia, Chicago, Milwaukee, and Rochester, N.Y., and that are funded wholly or in part by the stimulus bill—a sum equal to roughly one quarter of its annual revenue.

These initiatives are a boon for the minority of businesses whose core operations can be easily adapted to smart-economy projects. But in order for this effort to succeed, the impact has to be deeper. Creating entirely new types of businesses involves the government placing bets on specific technology sectors—and on specific technologies within those sectors. We invested in the interstate highway system in the 1950s for reasons of national security, but it had tremendous economic benefits that nobody could have anticipated, says Mark Zandi of Moody's Economy.com. The smart minds behind the smart economy, by contrast, believe they know the precise positive outcomes to be generated by investments in renewable energy. Energy Secretary Steven Chu may be a Nobel Prize–winning physicist. But as his department sifts through loan applications for different types of alternative-energy projects, will he prove to be a good venture capitalist? Should loan guarantees go to projects that use traditional solar panels or thin-film solar that can be stamped onto building materials?

And while they do create jobs, many alternative-energy projects aren't particularly labor-intensive. Wind farms don't require armies of workers to maintain them. In Colorado, government officials and executives have been talking up what Gov. Bill Ritter calls a new energy economy. The Denver region can boast thousands of new jobs connected to solar research and wind-turbine manufacturers, but they don't come close to making up for the 50,000-plus jobs lost in the area since the recession began. By 2018 investments in renewable power generation and transportation fuels, retrofitting buildings, and research could lead those sectors to employ 2.54 million jobs, according to the consulting firm Global Insight. That's nice, but hardly the difference between muddling through and a supercharged recovery.

The U.S. government does have a pretty good long-term record of midwifing new industries, and creating new commercial infrastructure that spurred massive private--sector investments. The state-funded Erie Canal, which led to massive growth in upstate New York and the upper Midwest, was followed by privately backed waterways. Congress built the first telegraph line from Baltimore to Washington in 1844 before entrepreneurs were struck by lightning, as the telegraph was called. The first transcontinental railroad was heavily financed and subsidized by Congress in the 1860s—and helped trigger a half-dozen copycat lines.

There are signs that public investment in green technology is already catalyzing some private investment. These are dust-bowl days for venture capital. But on July 22, eMeter Inc., a San Mateo, Calif.–based startup that makes smart-grid management software, says it raised $32 million in new venture-capital funding. The company, which has 160 employees, is betting its business will grow as some of the $4.5 billion earmarked for smart-grid technology flows to utilities. We're prepared to hire people rapidly once the stimulus action really starts, says eMeter CEO Cree Edwards.

When the private sector creates new infrastructure—with or without government help—all sorts of good things can happen. That was the case in the 1990s with the Internet. Seeking a repeat, the stimulus package allots $7.2 billion for expanding the nation's broadband infrastructure into mostly rural areas. (Only 63 percent of Americans subscribe to broadband at home.) What does stringing high-speed fiber into the hamlets and hollows of Appalachia have to do with job creation? Plenty, says Wally Bowen, founder and executive director of the Mountain Area Information Network (MAIN), a nonprofit wireless-Internet provider in western North Carolina. Many people who got on the Internet in the mid-'90s had real progress in their lives in these remote rural areas, managing their health conditions or a home business, only to be left behind when broadband passed them by, says Bowen. He cites an octogenarian widow in the small town of Murphy who has been supplementing her income with eBay, but has lately been having difficulty with dial-up. MAIN is part of a consortium of local businesses and public-private partnerships seeking $50 million in broadband stimulus money to lay new fiber and erect wireless towers. A study by Columbia University professor Raul Katz estimates that as many as 128,000 jobs could be gained over four years just in the construction of new networks.

The benefits from more investment in broadband and communications could extend far beyond elderly eBay sellers. As MIT researcher William Lehr says, Broadband is a key ingredient to make the rest of this smorgasbord of projects work. For example, the stimulus package included $19 billion to computerize health information, which would allow doctors, patients, and insurers to share data easily. The move, intended to save billions of dollars, has already spurred private-sector investments. In July, the networking giant Cisco and the huge insurer UnitedHealth announced plans to build a technology network for health providers, with the help of stimulus funds.

Digitizing health records is the ultimate no-brainer—the typical doctor's office is far lower-tech than the typical grocery store. But that may prove to be the easiest task in bringing the tenets of the smart economy to the vital health-care industry. The stimulus package contained plenty of cash for the sector, one of the few areas in which employment held up during the recession: $10 billion for the National Institutes of Health, and $24.7 billion in subsidies to help people who have lost their jobs to purchase coverage. But that's only the down payment. The case the Obama administration makes for its expensive, ambitious health-care-reform program is as much about economics as it is about social justice. Health care, 16 percent of the economy, is inefficient. The lack of affordable health insurance is a barrier to hiring and entrepreneurship. And a failure to control the cost of Medicare and Medicaid will crowd out other investments and make it more difficult to sustain consumption. If we do not control these costs, we will not be able to control our deficit, President Obama said in his occasionally combative July 22 press conference.

True. And that points out one of the challenges in relying on smarter health care to contribute meaningfully to economic growth. The reform envisions large new expenditures and investments: Congressional Budget Office estimates of major provisions yield a sticker price of $1 trillion over 10 years. But it's also supposed to generate huge cost savings through the application of technology, efficiencies, and negotiating power. A July report by the White House's Council of Economic Advisers states that health care is forecasted to remain a large source of job growth in the labor market, especially for positions like registered nurses and physical therapists. Yet the gale of productivity enhancement, reform, and cost control the Obama administration wants to unleash on the sector is likely to result in the reduction or elimination of many existing health-care jobs. The debate about the impact of health-care reform will continue to rage even if legislation is passed this year. And the plan that ultimately emerges—if one emerges—will likely be influenced more by interest-group and partisan politics than by smart-economy thinking. Audible in Washington last week: the sound of expectations being ratcheted down.

To a large degree, the U.S. economy must now cope with an era of lower expectations. Road building isn't a recipe for full employment, green technology won't displace fossil fuels in this decade, the benefits of universal broadband may be overblown, and the dysfunctional health-care system won't shift overnight from a headwind to a tailwind. The recession may be over, but there's likely to be plenty of tough slogging ahead.

Does that mean the smart economy is a waste? Absolutely not. Declaring the stimulus a failure five months after its passage is a little like calling the results of a marathon at the second-mile marker. Virtually all these investments are necessary. They will make the economy and specific industries smarter. They are intelligent economic and political strategies. But they're not sufficient. Large as it is, the stimulus can't fill the hole we've created or bring a series of large industries into the 21st century. Each imperative requires investments far in advance of what even the most free-spending liberal could imagine. Transforming the nation's energy production and transmission system will take an investment of trillions of dollars over decades, says Dan Arvizu, director of the National Renewable Energy Laboratory in Golden, Colo. "The private sector has to make this happen."

Historically, the economy has kicked into higher gear when a development comes along that can touch every part of the economy, not just particular sectors: the steam engine, electricity, the computer chip, globalization, the Internet, cheap money. By definition, it's almost impossible to know what the next disruptive, discontinuous great leap forward is going to be. On several occasions, Lawrence Summers has remarked that when he was involved in the big economic summit Bill Clinton held after winning the 1992 election, he didn't recall hearing many mentions of the words "the Internet."

Past performance is no guide to future returns. That's the disclaimer that every investment manager provides clients. And it's true in economic terms, as well. The U.S. has historically responded with resilience and flexibility to periods of economic distress. Despite the army of authors dedicated to the proposition that the New Deal was an unadulterated failure, FDR's efforts averted disaster, ended the nation's worst economic downturn, and created lasting infrastructure that has paid economic dividends for decades—from the Hoover Dam to the Appalachian Trail (the real one, not Mark Sanford's fictional one). History suggests, but doesn't guarantee, that the U.S. is likely to do so again.

Until the next big thing comes along, consumers and businesses will continue to do what they've been doing for the last several months: pay down debt, restructure, and focus on survival. Using federal resources as a lever and crutch, we'll have to take satisfaction in small, incremental gains. It'll be grueling work—much like repaving roads in Westport, Mass., in the middle of August.

Zoon Politikon)


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