Foldvary asks Is the US Economy in Recession?
|January 9, 2007||Posted by Fred Foldvary under Archive, Progress Report, The Progress Report|
Is the US Economy in Recession?
by Fred E. Foldvary, Senior Editor
The headlines say the economy of the U.S.A. has avoided a recession, as the gross domestic product grew by .7 % in the second quarter, April through June, 2001. A “recession” means that the economy recedes, meaning output is reduced. So long as national output or product does not decline, the economy is not officially in recession. So why does it feel like the economy is in a slump? As economists often say, “it depends.”
Whether an economy is officially in recession, or considered to be by economists, depends on how one defines and measures a recession. It seems to me that a more meaningful measure of boom and bust would be per-capita GDP rather than total GDP. The US population is growing at about .9 % per year (2.5 million annual growth, relative to a population of 284 million) , so output per person declined slightly in the second quarter at .2 %.
Suppose the population were growing at 10 % but the economy only grew at 2 %. There would be a significant reduction of personal income of 8 %. It would feel like a major recession in income and output. Per-capita GDP growth is more realistic than total GDP growth for the impact of changes in GDP on economic well-being.
But we can go further and ask, why measure recessions based on zero growth as the benchmark? Why not measure recessions as deviations from the long-run trend of GDP growth? Real per-capita GDP growth in the US since 1870 has been around 1.8 %, but after 1948 growth was 2.1%, and from 1996 to 1999 the US economy grew at a rate of 4.3 %, or (subtracting .8% population growth) 3.5 per capita, making the current slowdown a 3.5% reduction from recent growth. That’s why it hurts.
The main cause of the boom and bust cycle is the fluctuations in economic investment, the increase in the stock of capital goods. In the second quarter, business spending decreased by 13.6 %, with big declines in nonresidential construction and sales of equipment. Inventories, which are also an investment, shrank also.
A simple example will help us see the effects of slowing growth. Suppose there is an island economy with only three persons. Joe grows corn, Janet builds plows, and Judy makes shoes. One year, Joe said he would expand corn production, and would need extra plows, but then he changes his mind, because extra land costs too much, so he does not buy any extra plows. Janet has an excess inventory. She overinvested, anticipating growth which did not happen.
Janet could switch to corn farming, but it would take her time to get the land and learn how to grow corn. So she decides to do nothing and wait for Joe to buy the plows again. With no income, Janet stops buying shoes. So now Judy has less to trade, and she buys less corn, and Joe now has excess corn, and reduces his output also. Joe stops buying shoes, and now both Judy and Janet are unemployed.
But Joe’s plow eventually wears out, and he orders another one, and so Janet goes back to work, and with her income, she can now buy shoes again, and Janet and Judy can also buy more corn, so output goes back to normal. The reduction in spending for capital goods creates unemployment because labor and equipment cannot quickly shift to other products, and government interventions such as regulations and taxes make labor and enterprise that much more sticky and inflexible.
Investment in capital goods declines for several reasons. It becomes more expensive to invest as costs rise, especially real estate and interest rates. Also, an excessive growth in the money supply and credit artificially decrease interest rates, boosting investment in capital goods, but these become malinvestments, unprofitable enterprises which do not have sustainable revenues and profits. The late 1990s boom in technology was fueled by a flood of credit spent foolishly on capital goods such as web-based products for which there was too little consumer demand.
So these investments became instead a wasteful consumption of capital goods, and many loans and stock investments went bust. There is also excess inventory to clear. Lenders become fearful, while the collapse of some companies reduces demand for other goods. On a per-capita basis, compared to recent growth, the elimination of investment in capital goods cascades into reduced demand overall, with higher unemployment, even if total output does not decline.
The economy would recover quickly if taxes on labor and enterprise were immediately eliminated, shifting public revenue to land rent instead, because lower prices and higher wages and profits would stimulate production. That won’t happen, so we’ll have a slower recovery. Inventories will run down, technological progress will require more investment, the money supply is gushing up, and financial markets will regain confidence. There will most likely be one more economic hurrah, after which excessive money growth will lead to price inflation, and high real-estate costs and high interest rates could lead the economy over a waterfall, next time into a really severe depression. So the current slowdown could be warning of much worse to come.
Note: For GDP growth data, see http://www.cnie.org/nle/econ-112.html
Copyright 2001 by Fred E. Foldvary. All rights reserved. No part of this material may be reproduced or transmitted in any form or by any means, electronic or mechanical, which includes but is not limited to facsimile transmission, photocopying, recording, rekeying, or using any information storage or retrieval system, without giving full credit to Fred Foldvary and The Progress Report.
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