Harvard professor Gregory Mankiw, writing in the NY Times, gives 5 potential reasons for the current low growth in the U.S. His 5 are (1) it is a statistical mirage, (2) It is a hangover form the financial crisis, (3) secular stagnation per Lawrence Summers, (4) slower innovation per Robert Gordon, and (5) Policy missteps, maybe too much government stimulus and not enough reduced taxation. Mankiw says he does not know which is correct. Of course most of us could add to his list. Recently I have written about Gordon's work, which I think has great merit, and touched on the statistical mirage idea in that article as well, and I wrote about Summers' secular stagnation idea a few years ago, which I also think has merit.
But let me be less theoretical in my suggestion today. We suffered from a logical progression of important economic and demographic events that got us where we are today.
1. After two decades of subpar productivity growth, the economy broke through in 1996 and we had five years of robust productivity growth, possibly helped by a balanced federal budget and spending on Y2K, which was concentrated on high-productivity computer products and high-earning software engineers and consultants.
2. The stock market mistook that period of success for a new paradigm and rose by historic leaps, only to fall back in the Dotcom Bust of 2001, when the new paradigm was unmasked.
3. Coincident with the Dotcom bust and accompanying recession, Chinese production for export ramped up following China's accession to the WTO at the end of 2001, which cut the legs out from under American workers' bargaining position, contributing greatly to the stagnation of working class wages that has prevailed throughout the last decade and a half.
4. American workers, who should have prepared themselves for foreign low-cost competition that everyone knew would come some day, had failed to do so. American men had failed to get educated, beginning with the cohort born around 1950, which by 2000 included men aged between 20 and 50, quite a substantial part of the workforce.
5. At the same time, demographic factors were tending to make rapid growth more difficult. Since about 1970, American women gradually were having fewer children, and more of them were being born out of wedlock. Fewer children means a slower-growing population (good and bad), and more children being born to unmarried, less educated mothers means an uphill climb for the kids to get the educations they will need to compete globally.
6. The stage was now set for a fairly stagnant economy, which the Fed and many economists correctly diagnosed. Taxes and interest rates were cut significantly to promote more spending and investment. At the same time, the Bush Administration embarked on three wars in response to 9-11: War on Terrorism, Iraq and Afghanistan, all of them involving vast expenditures (and vast federal deficits).
7. The combination of spending and low interest rates created a period of apparent economic growth from 2003 to 2006, spurred in particular by an historic building boom and an historic rise in real estate prices. The boom was fueled also by spending from equity extraction as real estate prices escalated.
8. But the boom was illusory. It was fueled by debt (from both domestic and foreign sources) and rising prices, not by productivity increases and demographic benefits. Therefore when real estate prices began to crest and decline in late 2005, the process began to reverse itself. And by 2007, the downdraft was in full force and gathering power.
9. At the same time that real estate prices were declining, spending on wars also declined. And the people who had invaded their real estate equity to buy Lexuses and nice vacations now found themselves unable to borrow more and having to pay back what they had borrowed. The foreclosure tsunami that began at the end of 2006 just gathered steam, feeding on itself as communities became progressively less desirable as more homes were foreclosed upon and lower prices made it impossible for many people to move to where their job prospects might have been better.
10. And that is where we still are seven years after the end of the recession and financial crisis, despite great efforts by the Fed and others to spur economic activity. Jobs have recovered considerably, but labor's bargaining power has not. Business investment remains weak-lots of blame goes around for that, but maybe there is no blame. Maybe businesses are acting rationally in light of existing opportunities. Interest rates remain low all over the globe, suggesting that is a natural phenomenon, not one that has been brought on by central banks.
I could write a true megilla about these factors. And I have written two books about some of them- Debt Spiral and The Education Solution. They cover the illusory boom and the educational bust and the demographic changes of the period 1970 to 2010.
I will give you just three figures here, one from Debt Spiral, one that illustrates the Debt Spiral data in graphic format, and one from Calculated Risk.com that expands on the backup for the Debt Spiral figure. The important point of those figures is that the 2003-2006 boom was illusory and covered up a fundamentally weak economy-and that weak growth is what has continued to this day. Here is what I said at page 7 of Debt Spiral:
Here is my figure that illustrates this graphically.
As you can see, without equity extraction expenditures, there would, all things being equal, have been no real GDP growth in the apparent boom years.
The Greenspan-Kennedy study of 2007 has been followed up on a regular basis by Bill McBride at Calculated Risk. Here is Bill's graph that takes the data through 2014.
As you can see from Bill's graph, the impact of equity extraction continued to be negative right through 2014, reflecting people paying down their mortgages and HELOCs rather than spending. It appears that we are now at the end of that process, and with real estate prices going up, the more normal positive trend of the 1990s should prevail, and that headwind should abate.
Readers will have noted that I have not discussed neither the financial crisis and its impact nor the frauds committed by many types of parties as the real estate market pumped up. Those things happened, and they contributed to the debacle, without doubt. But they are not responsible for where we are today.
I do not have a formula for how to get to a better economic place than the one we are in. Cutting some red tape that holds people and businesses back would be a good idea, so would some infrastructure spending. And long term, we have to address the problem of educating the children of young, less-educated unmarried mothers. 40% of American kids are being born to unmarried mothers, many of whom are good mothers but many of whom are not equipped to deal with the stresses and exigencies of single parenthood and children's needs in a complex world.
I see no quick fixes. When the pie appears to be static, it is tempting to ask for radical measures: on the left to ask for radical redistribution in the name of fairness; on the right to repeal regulatory systems and taxes on the ground that they hold people back from creative ventures. Neither of those ways seems to me to be how the U.S. has flourished over the last couple of centuries. We have flourished by cooperation, by supporting the education of our people, and by gradually growing the economic pie for everyone's good. That, it seems, was easier in an earlier time, but that does not mean we should abandon the principles that have served us well.
In the kind of world that I see, the equity markets should grow modestly and interest rates should remain low. There is no economy outside the U.S. to pull the global train. Most of the others are at greater risk than we are.
Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.
I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.