What's So Bad About A Nice Little Recovery?By
As Americans start looking beyond the recession toward the emergent recovery, a new national concern has surfaced: the fear that the coming recovery will be one of the weakest ever. The history of postwar recessions shows that our economy has typically grown 4% to 6% per year in the first year or two following a recession trough. This time around, however, virtually no one expects such stellar performance. Most forecasters look for annual growth rates in the 2.5%-to-3% range once we bottom out and start to ascend.
On the surface, that seems a doleful prognosis. But is it? To put the popular forecast of a weak recovery into proper historical perspective, we should remember three things.
First, it now seems likely that the 1990-91 recession will be one of the shallowest on record--just as last year's optimists predicted. Real gross national product has declined only 1% so far, and, with a little bit of luck, that is as far down as it will go. By comparison, real GNP declined by an average of 2.3% in the eight previous postwar recessions. Shallow recessions are followed by weak recoveries for a simple reason: An economy that has not fallen far has little catching up to do. And catch-up is the main reason economies zoom upward in the early stages of recovery.
The second thing to remember is that the U. S. economy's underlying growth rate today is much lower than it was earlier in the postwar period. Why? A growing economy's capacity to produce goods and services normally expands from one year to the next because more people are working and they are more productive. But productivity growth has slowed alarmingly in the past two decades, and labor-force growth has fallen off slightly in recent years. With the labor force now growing at just under 1% per year and productivity inching up at a paltry 1.3% rate, the underlying growth trend today is only about 2.2% per year--a far cry from the 4%-plus rates that typified earlier decades.
SHORT CLIMB. The implication is that a 1% decline in real GNP today represents less of a valley than it once did. During the 1950s and 1960s, a year of 1% decline in GNP would have left the economy about 5% below trend--the 1% drop plus the 4% growth that failed to materialize. But with our current trend growth rate somewhere between 2% and 2.5%, that same 1% decline today leaves us only 3% to 3.5% below trend.
Putting these two points together leads to a rather sanguine conclusion. Since the uphill climb in the coming recovery will be much shorter than was
typical in previous postwar recoveries, we should be neither surprised nor dismayed if the rate of ascent is less steep. In short, a recovery that looks puny by historical standards may be quite appropriate today.
Let me be more specific. Specifically, suppose GNP in the second quarter of 1991 is unchanged from the first quarter. Then, over the preceding year, our economy will have fallen 0.8% when it should have grown, say, 2.2%--leaving a GNP shortfall of just 3%. If we make all that up in two years, which would be a fine performance, growth will average 3.7% per year (2.2% trend growth plus 1.5% catch-up). If full recovery takes three years instead, the average growth rate will be 3.2% (2.2% trend plus 1% catch-up).
JUST RIGHT. This reasoning leads me to conclude that a reasonable growth target for the coming recovery would be in the neighborhood of 3.5% for the next two or three years. That's a much slower pace than most recoveries, and it's only slightly better than the currently popular forecasts. But it would be just about right for 1991-93.
At this point, naysayers will raise a host of objections. Sure, a growth rate of 3.5% might be enough to get us back to full employment. But how will we get even that much at a time when state and local governments are cutting back, commercial construction is dead in the water, the consumer may be tapped out, and the export boom is running out of steam? Won't these impediments block even a modest recovery?
My answer is: Maybe, but probably not. And that brings me to the third and final lesson of history, which is that optimism is a scarce commodity at the bottom of a recession. At such times, contemporary observers have often wondered what would pull the economy out of the muck and underestimated the strength of the ensuing recovery. The pervasive pessimism at the trough of the 1981-82 recession was a particularly clear example.
What sector or sectors will lead the economy out of recession this time? No one really knows. But if history is any guide, some sector will rise to the occasion. The hero is unlikely to be government spending: Federal fiscal policy is paralyzed, and state budgets are in disarray. That leaves the good old private sector--assisted by its trusty sidekick, the Federal Reserve. For this reason, one more ratcheting down of short-term interest rates would be most welcome.
Furthermore, the prospects of an economy propelled forward by monetary rather than fiscal stimulus--and thus by investment rather than government spending--is quite appealing. Mr. Greenspan, are you listening?
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