State of the Union 2012

I recently read a 1953 Time article that was more or less discussing the definition of a recession. It was an interesting read because it pointed out different views on the definition more eloquently than I have done so in the past. If you ask an economist what a recession is, you’ll be told that it is negative GDP growth for a couple consecutive quarters. When somebody on Wall Street is asked, he or she would answer with something pertaining to a reduction in stock market prices. Ask a labor union leader and you’ll hear references to unemployment rates. Retailers will tell you that a recession is a drop in sales. And the reality is: all of these answers are correct in their own way.

In our own current economic climate, we are witnessing jobless economic recovery. GDP and stock market indices have been on the rise; however, unemployment has remained disastrously high. Nationally, the unemployment rate is 8.5 percent but some states, like Nevada, are as high as 12.6 percent.

So what has the Obama Administration been doing to combat the unemployment rate? The short answer is: nothing. The long answer is a bit more complex. Recently, the administration has been advocating the American Jobs Act. The cost of the legislation when originally purposed was about $447B and was roughly 50 percent tax cuts and 50 percent spending on infrastructure and projects designed to offer job security to teachers, police officers, and firefighters. Naturally, this bill did not make it through Congress and has since been split up into smaller bills that are still trying to make their way through the legislative process. To make matters worse, even if the American Jobs Act would have managed to pass, I believe it would have been a waste of money. The results would have been less than satisfactory as the gaping hole in our economy is too large. Let’s dive into a little math here:

Econ 101 textbooks offer a rule called Okun’s Law. This rule states the relationship between the unemployment rate and GDP growth. The gist is simple: for every 1% of unemployment (above the 3% natural rate) GDP suffers a 2-3% (this is the Okun coefficient) reduction in output. Currently, GDP is $14.58T and the unemployment rate is 8.5%. That means the unemployment rate beyond the natural rate is 5.5%. Using Okun’s coefficient, we can calculate that GDP is currently suffering between 11-16.5%. In turn, we can then calculate this in dollars: there is roughly a $1.6 - 2.4T hole in the economy. Or in other words, it would take upwards of $2.4T in stimulus spending to bring unemployment down to the natural rate of 3%. As you can see, the $447B American Jobs Act wouldn’t have done much. This, of course, brings me back to my point that the Obama Administration hasn’t been doing anything about jobs.

In my simple calculation of Okun’s Law, I held a number of things constant and made a few assumptions. I didn’t account for underemployment or discouraged workers who left the labor market. I also didn’t forecast or adjust for stimulus spending multipliers like gov’t purchases vs. tax cuts. I could have also given a range for the natural rate of unemployment between 3-5%. Therefore, my figures may be somewhat debatable depending on who you ask. But at least it is a starting point. And it was a starting point that Obama chose to ignore 3 years ago when deciding on the first stimulus package.

Keeping this all in mind, even if Congress actually acted in our best interest and granted us the desperately needed stimulus money, this would only be a short term solution. A temporary patch for employment does nothing to promote long term economic growth. Sure, in the short run, a huge stimulus package will boost the economy, GDP will rise, the unemployment rate will go down, and the federal deficit will shrink because of all the people going back to work. It’d be a great political victory. However, America will eventually have to return to the realization that the manufacturing jobs that once defined the middle class are gone and will never return. Read this NY Times article on Apple manufacturing for case and point.

Ultimately, we’ll lose our place as a world leader because of the systematic defunding of higher education (we need more mathematicians, engineers, scientists –see Romer Growth Model), poor infrastructure, disastrous inequality and consolidation of wealth, a financial industry refusing to engage in anything less than cowboy capitalism, reluctance to subsidize and incentivize renewable energy, a still decimated housing industry, and more. Without addressing these issues, America will never return to previous heights.

The government is burning the candle at both ends by marginalizing the middle and lower classes while mainly promoting policies designed to benefit the wealthy and multinational corporations. The current path is unsustainable. Our GDP is comprised overwhelmingly (70%) of personal consumption expenditures. Consuming goods (e.g. cars, groceries, homes, etc) is the main driver of our economy, plain and simple. It’s a consumption bubble that bursts every time unemployment increases. It’s not like the old days when our country had a huge trade surplus and the economy could still thrive when domestic demand dwindled. Therefore, we must keep in mind that it’s the middle and lower classes, and SMALL businesses (i.e. less than 500 employees) that push the economy. It’s not the top 1% that accounts for the majority of personal consumption expenditures. It’s not the huge multinational corporations who create the vast majority of jobs (in America). We have a serious Say’s Law problem in the U.S.: supply doesn’t create its own demand. And that’s the problem with this Reaganesque trickle-down ideology that still plagues our political system.

Well what about monetary policy? Why haven’t they come to the rescue? In summary, the Fed still has its hands tied. Monetary policy isn’t able to do much and won’t be able to for awhile. There was a recent announcement that the federal funds rate will remain near 0% for the next two years. This, of course, is pretty much all the Fed can hope to do right now. They need provide liquidity to the banks and remain the lender of last resort (one of the lessons from the Great Depression). They also announced to target inflation at around 2%. However, I won’t bother making the case for higher inflation and economic growth right now. I’ll save that for another day.

And this has been my State of the Union address for 2012.