Although the U.S. job market has recently shown signs of improvement, economists are increasingly concerned that the current recovery is unsustainable. Economic gains are primarily the result of increased profits, not wages. Thus, households - and ultimately the economy as a whole - have had to borrow record amounts of debt to sustain economic growth. As interest rates begin to rise, households will be more vulnerable to rate increases than ever before. All of this is happening at a time when the trade deficit and foreign debt are approaching unsustainable levels. To make the economic recovery sustainable, economic growth needs to be income and not debt driven.
A weak labor market has resulted in debt driven growth. Estimates from the Center for American Progress show that after tax profit rates reached record highs in 2003, yet personal wage and salary disbursements have gone up only 1 percent since the end of the recession (an extremely low growth rate by historical standards). This worries experts, including Morgan Stanley's chief economist, Stephen Roach. In a recent presentation, Roach cautioned that consumers are relying too heavily on debt to finance consumption. As households are saving less and the government is accruing large deficits, the U.S. economy has begun to borrow more money from overseas. This is contributing to near-record trade deficits that will ultimately take a toll on economic growth and living standards.
Deficits and a stronger economy will lead to higher interest rates, taking a bite out of households' wallets. As interest rates rise, record debt burdens will take a toll on household income and lead to rising default rates and growing bankruptcies. The administration's appetite for debt and economic growth has already led to higher long-term interest rates. Households are vulnerable to interest rate increases as they have borrowed debt without fixed interest rates. Thus, while fiscal policy and monetary policy aided in the recovery, they may now exact a price on economic growth because consumers are more vulnerable to higher interest rates.
A sustainable recovery must incorporate stronger income growth. The economic recovery has largely been debt driven to this point. To make it sustainable, it needs to be income driven. Faster income growth will make households less vulnerable to interest rate increases and help stabilize consumption. More stable consumption growth will also lead to broader and deeper investment growth, a crucial component for durable growth.
For more information on sustainable economic growth, see this Center for American Progress report. Daily Talking Points is a product of the Center for American Progress, a non-partisan research and educational institute committed to progressive principles for a strong, just and free America.
http://www.americanprogress.org/site/pp.asp?c=biJRJ8OVF&b=87502