ON A PATH TO RECOVERY OR IN THE IRONS?
By O. Homer Erekson
To a sailor, being aware of the direction of the wind is a key determinant of being able to make forward progress. Sailing straight into the eye of the wind puts the boat “in the irons” and stops it dead in the water. As Jimmy Dean has said, “I can’t change the direction of the wind, but I can adjust my sails to always reach my destination.”
As we look to the economy in 2012, it will be helpful to consider the headwinds affecting the economy and whether we are on a path to recovery or slowing to a dead stop.
After a somewhat brief rally in the last quarter of 2009 and through 2010, when the quarter-to-quarter growth in real gross domestic product (GDP) was in the two to four percent range, we have returned to a slower growth pattern for 2011 with growth rates less than two percent. During this entire period, however, the growth rate in real GDP for Texas has stayed well above the national average.
An October 2011 Conference Board report noted, “The U.S. Economy is uncomfortably close to contracting, with a 50-50 chance of falling into recession. The key silver lining is that if it does tip into a downturn, it is likely to be short and shallow – as resource usage in both the product and labor markets remains so low. The unemployment rate hovers at nine percent and the capacity utilization rate at a low of 77.4 percent. These metrics reflect much more slack in the economy than is typically the case before a recessionary downturn. Thus, the benefit of so little recovery is that, absent an unexpectedly large downward shock, there isn’t that much room to fall.”
The fundamental problems facing our economy are familiar. We have housing and financial crises caused by borrowing and spending well beyond reason. Our federal and state and local governments have accumulated unsustainable levels of debt. The European sovereign debt crisis has created a contagion effect challenging the ability for financial markets to write down or restructure its basis. And we have had extraordinary events, including weather, earthquakes and international political events that have strained the ability of the global economy to meet basic resource supplies.
Reason for Optimism
Even in the midst of these challenges, there are recent signs of optimism for the economy. In contrast to August 2011 when unemployment rates increased in 26 states, unemployment rates in September increased in only 14 states with 25 states having a decline in rates. Texas continued to be a leader with over 15,000 jobs created in September, second best in the nation. Claims for unemployment insurance also declined in mid-October.
There also were signs that inflation was still not posing a significant problem in the short run with the overall consumer price index increasing only 0.3 percent in September, and core inflation increasing only 0.1 percent.
Business activity also showed positive signs. Businesses added to inventory for the 20th consecutive month in September with retail sales having its biggest gain in seven months. Corporate balance sheets remain strong with cash holdings growing to over $2 trillion.
Despite these positive signs, consumers, business executives and economists do not see the U.S. economy in a strong and growing position. Respondents in the Ewing Marion Kauffman Foundation fourth-quarter survey typify the U.S. economy as being “uncertain” or “fragile” and have a “nearly unanimous view of the economy as mixed, facing recession or in recession.”
Consumer confidence is critical to a growing economy with consumer expenditures accounting for approximately 70 percent of GDP. The Conference Board Consumer Confidence Index indicates that consumers still believe the U.S. economy is stagnant, with over 20 percent of consumers expecting business conditions to worsen.
Although the most recent month has shown an improvement in unemployment, the overall unemployment rate continues to hover around nine percent. Two dimensions of unemployment are challenging. With consumer expenditures and aggregate demand still depressed, cyclical unemployment continues to be a significant contributor to the overall unemployment rate. There were three times as many unemployed workers than available online job openings. Older workers have also delayed retirement, resulting in fewer openings for younger and new workers. And as people become discouraged and stop looking for work, they are not counted among the unemployed. Thus, the actual unemployment rate may well be higher than measured unemployment.
An even more significant challenge in addressing unemployment in the long run is matching employment opportunities to the skill set of those seeking employment. Structural unemployment looks to be an ongoing concern with the lack of computer and other technical skills for jobless Americans. When coupled with the limited mobility of workers due to low housing values, policy decisions to extend unemployment benefits, and the failure of the K-12 public school systems to provide adequate skills development for the work force, the probability of ongoing structural employment issues is high.
During this period of recession and modest recovery, portfolio volatility has become a seeming norm with investor resolve challenged by a near 14 percent decline in the S&P 500 during the third quarter. A commonly cited argument is that uncertainty in the business environment results in companies being unwilling to invest their cash to create new jobs.
Three economists Scott Baker, Nicholas Baker and Steven Davis have argued from their recent research that “a major factor behind the weak recovery and gloomy outlook is a climate of policy-induced economic uncertainty.” They claim that “the recent financial crisis created an atmosphere of extreme uncertainty” and “reflects deliberate policy decisions, harmful rhetorical attacks on business and ‘millionaires,’ failure to tackle entitlement reforms and fiscal imbalances, and political brinkmanship.”
One might argue that the headwinds for the economy are rooted in this economic uncertainty. That is, companies may wait for more stable times before hiring or making investments, thus by itself delaying a more robust recovery. Will steering the economy into these uncertain and volatile winds result in the economy being locked “In the Irons”?
The counter argument is that market volatility provides opportunities for investors. Sophisticated entrepreneurs and investors are able to take advantage of market uncertainty, identifying market opportunities and gaining first mover advantage.
In an October 31 Time article, Rana Foroohar writes that “expanding trade, ensuring energy security, investing in infrastructure and providing job-stimulating tax incentives . . . could create employment . . . but won’t fundamentally change the global headwinds the U.S. has been facing for four decades.” Rather she argues that the integration of China, India, Brazil and Russia and other emerging economies into the global economy has impacted the global labor market, driving down labor costs, and moving American jobs to other countries.
Steering Ahead Into 2012
Looking ahead to the future, it might be best to just say “things will get better” . . . and not to provide a timeline. If one believes in the market and the ability for consumers and business to adapt to changing conditions, the future will be better.
In looking ahead to 2012, however, it is important to separate long run and short run perspectives. Long run improvement for the economy centers around investing in infrastructure, addressing excessive regulatory processes, strengthening the public education system and addressing long term debt obligations arising from unsustainable public programs.
The short run requires regaining consumer and business confidence, rather than looking for quick fixes in monetary or fiscal policy. There is significant pent up demand in many sectors, including housing. With the decline in the median sales price of existing homes and low mortgage rates, the housing market will begin seeing positive change during 2012.
Retail sales experienced the biggest gain in the last seven months in September, and likely will continue to show healthy levels during the last quarter of 2011. While the productivity increase enjoyed in the U.S. during the recession was fueled by layoffs and while productivity growth is likely to moderate in 2012, emerging economies will continue to drive global productivity growth.
While there are encouraging signs for the U.S. economy heading into 2012, private sector hiring is not likely to result in a significant increase in net new jobs. With unemployment likely to stay around 9 percent during 2012, there is unlikely to be a large enough increase in consumer spending to fuel a strong recovery. But with an “added worker effect” as more people begin seeking jobs, the measured unemployment rate may slightly mask the improvements that we are beginning to see in the economy.
In summary, 2012 looks to be a continued period of slow growth, with little change in unemployment, but low levels of inflation. Of course, any significant shocks to the economy, whether caused by natural forces such as weather or by ill-designed policy moves, could cause significant disruption in consumer and business confidence and spending. If we trim the sails, and are comfortable with a “close reach,” we are likely to see real GDP growing at about 1.5 percent, unemployment at around nine percent, and inflation staying under two percent.
Things will get better . . .
O. Homer Erekson is the John V. Roach Dean and Professor of Managerial Economics and Strategy at the Neeley School of Business, TCU, Fort Worth.
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