New York Times Sunday, December 30, 2001
Recession, Then a Boom? Maybe Not This Time
By DAVID LEONHARDT
In decades past, the next step for an American economy in recession would be clear. It would boom.
People would start spending again, and companies would quickly increase production, creating hundreds of thousands of jobs and fattening paychecks. In a quickly widening spiral, these developments would lead to even more spending.
But the rules for recoveries may well be different today - not because of Sept. 11, but because of fundamental changes in the economy. Even after a year-end flurry of good news on home sales, consumer confidence and jobless claims, the recovery likely to start in 2002 could be far weaker than those in other years that have followed downturns.
A limited rebound would have a broad impact on the way people live and businesses function, whether because unemployment stays high, corporate earnings continue to be sluggish or the stock market is slow to rebound. It could also shape much of the political debate leading into the midterm Congressional elections.
The most basic change is that recessions are less common today than they were in the 1950's, 60's and 70's. The service sector, which is less prone to volatile swings than the manufacturing sector, has grown rapidly, and the Federal Reserve appears more adept at managing the economy.
But when downturns are infrequent - roughly once a decade, rather than twice - the often-overlooked price is that the ensuing recoveries are neither sharp nor simple. "Because we get smaller downs," said Van Jolissaint, the corporate economist at DaimlerChrysler (news/quote), "we also get smaller ups."
The last three decades have included the long downturn of the mid-1970's, the double- dip recession of the early 80's and the short recession and weak recovery of the early 90's. Only severe downturns, like the second one in the early 80's, have produced rebounds as robust as those of earlier decades.
Not since 1970 has a strong recovery followed a brief recession - and it is just such a sequence that would be necessary for the coming year to be a prosperous one.
Since 1980, the nation's number of jobs rose just 3 percent, on average, in the two years after a recession. >From the 1950's through the 70's, the average increase was 7 percent.
In the old days, the American economy would slow to a crawl whenever consumers and companies decided they could squeeze a bit more life out of products and machines they already owned. When people began shopping again, factories cranked up quickly to meet the demand.
Today, technology allows factory stockpiles, and the spending swings they create, to be smaller. Service businesses, which need smaller inventories, make up a bigger share of the economy. And many tasks once done by the federal government have moved to the states, which often cut budgets just as a recovery begins.
The trade-off is a good one over all, most economists say. A more stable economy allows companies and households to plan better for the future, making them more efficient. And volatility brings economic pain by making people constantly anxious about losing their jobs.
Of course, arguments still rage about just how small the next upswing will be, but the terms of the debate reflect the new realities.
Even Wall Street forecasters, who regularly err on the side of optimism, do not expect the coming year to resemble the recoveries of decades past. Most predict that the economy will accelerate only gradually. Its best performance will be in the year's final quarter, when it will grow 3.9 percent, at an inflation-adjusted annual rate, according to an average of dozens of forecasts compiled by Blue Chip Economic Indicators, a newsletter.
In past decades, although the economy did not seem as strong as it is today, growth often reached 8 percent and higher in the wake of even mild recessions.
The two different messages coming from the Fed recently highlight the contrast. Alan Greenspan, the Fed chairman, has continued to trumpet corporate America's adoption of new technologies, which he says have increased productivity and will lift the long-term growth rate. Other Fed officials share that opinion, but many have also said recently that they expect the recovery to be slow.
Indeed, the slow recovery of the early 90's, rather than seeming to be an aberration, has become the reference point for the argument now confronting economists.
On one side of the debate is the cash crowd - those who believe that the trillions of dollars recently injected into the economy will cause demand to surge soon for everything from clothing to workers. Pointing to the Fed's many interest-rate cuts, the tax cut of last summer and gasoline prices that remain lower than they were 5, 10 or 20 years ago, the cash crowd says the economy will do better in the next few years than it did in the early 90's.
"The economy is awash in a sea of liquidity," said David Littmann, the chief economist at Comerica Bank in Detroit, who counts himself an optimist. He is joined by many investors and, based on their public statements, Bush administration officials.
"People aren't comfortable with an unusual amount of cash, and the economy will be jump-started by the liquidity," Mr. Littmann said.
On the other side is the overhang crowd - those who say that all that money will not be enough to counter the structural imbalances in the economy. These worriers say that many businesses still have more equipment than they can use profitably and that consumers, who cut spending far less this year than in previous downturns and still have high debt levels, may not raise their spending much in coming months.
"This is a major, long-term balance-sheet adjustment that is long overdue," said David A. Levy, chairman of the Jerome Levy Forecasting Center in Mount Kisco, N.Y. His concerns are shared by academic economists who rely on history as a predictor and by many executives, whose profits continue to fall amid sluggish sales and stagnant prices. You cannot store a haircut. That fact goes a long way toward explaining why the nature of the business cycle appears to have changed.
When an economy slows, and households and companies start to reduce their spending, they often cut back most on manufactured goods. A family gets by with a creaky washing machine for a year more than it had planned. A business, expecting future sales to be slow, uses up the goods sitting in its warehouse.
Many services are harder to do without. Consumers cannot keep extra plumbers' visits on hand or postpone spending on child care. College tuition, doctor bills and car repairs cannot be put off.
On the other hand, when good times seem to return, people do not get a few haircuts at a time. They might buy a new television, however, or, if they run a company, decide to build a factory.
The implications for the economy are obvious: The service sector does not shrink, or grow, as fast as the manufacturing sector. And the service sector now accounts for about 80 percent of all jobs in the United States, up from 60 percent in 1960, as a result of the country's higher wealth and the move of manufacturing jobs to other countries.
The manufacturers that have remained in the United States, and the retailers selling their and others' products, have also been able to decrease the size of their own stockpiles. Many - most famously Wal- Mart - have used enormous computer databases to match inventory and sales levels more accurately.
The technology industry itself plays a role. Its products last a shorter time than, say, a car, and its factories need less time to build up or wind down. "It's just a much shorter production cycle," said Robert Gordon, an economist at Northwestern University. "We will get an inventory bounce-back in 2002, but technology has less of an inventory cycle."
Even during the most optimistic days of the late 1990's, overall inventory levels remained about 10 percent lower than they did during the 1980's, relative to sales, according to Economy.com, a consulting firm in West Chester, Pa.
"By tying everyone together, technology has given everyone the same information at the same time," said William S. Stavropoulos, the chairman of Dow Chemical (news/quote). "You're not always looking back, saying, `I wish I did this.' "
That lack of regret means that fewer companies are drastically increasing or cutting production in an effort to catch up with a trend they think they might be missing. As a result, economists say, the economy makes fewer sharp turns.
The thinning of inventories can still cause economic pain, as it has this year, when companies reduced their stockpiles by $55 billion, erasing a similar buildup in 2000, according to Goldman, Sachs. But given the size of the boom, analysts say the swing would have been even bigger in the past and might have produced a bigger rebound, too.
As it is, the rebuilding of inventories will add to economic growth next year, forecasters say, but it will probably have to swim against the tide of lower state and local government spending.
As the federal government has shrunk over the last decade, states have become responsible for a larger portion of public spending. Unlike Congress, which can approve deficit spending to soften a recession's impact, most state legislatures are required by their constitutions not to spend more than they take in. Because tax receipts have fallen in the recession, many states will cut programs and employees next year.
"The states are not in the business of supporting the economy," said Peter Temin, an economist at the Massachusetts Institute of Technology. "They are in the business of balancing their budgets."
Add it all up, and the consensus forecast is for less economic growth in 2002 than in any year of the decade-long expansion, according to Blue Chip Economic Indicators.
As much of a change as that would be from recoveries of some recent decades, it would not be entirely new. From the Civil War to World War II, huge increases in investment - in housing, railroads and other infrastructure - were often followed by busts or uneven recoveries. Today, some economists believe that a slow recovery is just what the country needs to return to healthy growth down the line.
"The best thing is actually to go through a process where you're going to have some sluggish growth, working off these imbalances," said Mr. Levy of the forecasting center. "The worst thing that could happen is if we somehow got another boom going now."