By Gary S. Becker
During most of 2002 and early 2003, many pessimists among business and academic economists, Democratic politicians, and media pundits worried about the slowdown in the U.S. In retrospect, it is amusing how many comparisons were drawn between the U.S. recovery and Japan's long stagnation. But the general concern was that the world's largest economy would stagnate for years, dragging down the global economy.
Since a few American price indexes briefly declined, there was a fear even among some Federal Reserve officials that price deflation would further depress the economy. Also emphasized was the sharp decline in payroll employment and a rise in unemployment, to 6.4%, from a low reached during the '90s of less than 4%.
YET I CONTINUED TO ARGUE that pessimists overlooked crucial factors that made the performance impressive, despite the recession and slow recovery. The U.S. had been exposed to a rapid series of devastating shocks that would have sunk much weaker economies. These began with the collapse of the high-tech bubble, fed by unrealistic expectations that drove stock prices and investments in various industries to ridiculous heights. Then came the deadly, unanticipated September 11 attacks, the subsequent war against the Taliban and Al Qaeda in Afghanistan, the war with Iraq, and a difficult postwar occupation. Last but far from least were the accounting frauds at Enron, WorldCom, and other companies that shook world confidence in American business.
Nevertheless, the recession that began in March, 2001, officially lasted only eight months. The subsequent recovery was slow, although not unusually so, and total output grew during the entire recovery. The most disturbing feature was the sharp decline in employment seen in the Bureau of Labor Statistics payroll data. According to the bureau's household survey, the unemployment rate's peak was well under peaks reached in most prior U.S. recessions.
The pessimists went wrong because they overlooked an encouraging statistic that continued during bad times: a rapid improvement in productivity. Measured productivity usually falls sharply during recessions and early stages of recoveries, partly because of unused capacity of equipment, plants, and employed workers. Yet even though 1995-2000 had unusually high productivity growth, productivity accelerated rather than slowed during most of the recession and recovery. Labor productivity in the third quarter of 2003 grew at an annual rate of 9.4%, the highest quarterly rate in decades.
This productivity growth is the key measure and reflection of the enormous underlying strengths of the U.S. economy. Its prime movers are the entrepreneurial spirit, worker flexibility and dynamism, and relatively free and open markets that allowed the economy to benefit from the technological revolution brought about by the computer, Internet, wireless communications, biotech, and other recent major innovations. The much-criticized Bush tax cuts will definitely help the economy grow more rapidly in the longer run, but they probably played a small role during this recovery.
Forecasting short-term movements in the economy is difficult, but readers expect crystal ball-gazing from economists at the beginning of a new year. So here are my brief assessments of the prospects for 2004. Productivity and aggregate output should grow at a rapid rate, although neither will be close to the third quarter of 2003. Employment will also continue to improve, and unemployment will decline considerably below the current level of a little under 6%.
If the American economy meets these expectations, it will greatly benefit the rest of the world, as U.S. industry and consumers import more goods, materials, and capital equipment. More important, it will show that nothing about modern economic conditions prevents rapid output and productivity growth in Europe, Japan, and other rich economies.
Foolish regulatory, taxation, and bankruptcy policies -- not underlying economic forces -- caused these economies to stagnate during the past decade. The recent liberalization of labor markets and lower taxes in Germany and a few other European economies, along with Japan's gradual willingness to tackle its banking crisis and regulatory burden, are hopeful signs. These nations too finally may begin to take much better advantage of the great economic potential offered by modern technologies and knowledge.
Gary S. Becker, the 1992 Nobel laureate, teaches at the University of Chicago and is a Fellow of the Hoover Institution.