1. Digging out from the Great Recession: Prospects for Jobs and Economic Growth Labor and Employment Relations Association Presidential Address January 8, 2011 Eileen Appelbaum Center for Economic and Policy Research

2. Digging out from the Great Recession Where we are How did things go so wrong? Experiment with laissez-faire capitalism Collapse of the housing bubble Financial meltdown Job market in crisis Inadequate policy response Government deficit Short-term: Not a burden Long-term: It’s health care costs Digging out

3. Worst Recession in More than 60 Years Compared to previous recessions: GDP fell further Capacity utilization declined more Downturn lasted longer (Dec ’07 – June ’09) Payroll employment fell further Unemployment increased the most Global recession

4. Experiment with Laissez-Faire Capitalism Deregulation of financial markets (Since 1980s) Innovative financial products: Derivatives, credit default swaps, etc. Lax regulatory oversight: Markets to discipline participants Relaxation of underwriting standards for mortgages Belief of economists in power of monetary policy to stabilize economy Greenspan, Bernanke, elite economists ignored warning signs Massive surge in house prices, rise in stock prices Catastrophic performance contradicts efficient markets thesis

5. Experiment with Laissez-Faire Capitalism Deregulation of Labor Markets Push to make labor markets more ‘flexible’ Trade agreements: Blue collar workers face global competition Lax enforcement of labor/employment law Unions weakened; more workers subject to ‘employment-at-will’ Value of real minimum wage allowed to decline Power in wage setting shifted to employers Wages stagnated, inequality increased

6. Share of Total Income Going to Top 1 Percent of Households, 1913-2010

7. Debt-Driven Growth Economic growth: Debt driven, rather than wage driven Debt of average American household: 1990: 83% of income 2000: 92% of income 2007: 130% of income 2005-7: Savings out of disposable income fell to less than 1% What made this possible? Clinton/Bush era housing bubble Weak regulation of financial market players Securitization of mortgages Homeowners refinanced, took equity out via cash or HELOC Assumption: House prices would never fall

8. Stagnant Real Wages but Increasing Consumption, 2000-2010

9. Housing Bubble Phase I: 1996-2002 Stock market bubble fueled demand for bigger/better homes Stock market bubble collapsed, 2000-02: Real estate seen as safe I 30% increase in inflation-adjusted house prices by 2006 Phase II: 2002-2006 Low interest rates: 30 yr mortgage rate fell to 5.25% in 2003 Lax underwriting, financial ‘innovation’ House prices increased a further 32% from 4 th Q-2002 to 4 th Q-2006 Run-up in real house prices 1996-2006: $8 trillion in bubble wealth Wealth effect added $400-$500 billion a year to consumption Savings rate fell to less than 1% in 2005-2007 Starts peaked at 2.1 million in 2005, 50% above pre-bubble

10. Collapse of the Housing Bubble House prices peaked in 2006, then fell substantially 2006-08: Housing wealth declined $6.4 trillion Decline in consumption (wealth effect in reverse) Demand for houses: Residential construction collapsed Economy went into recession: December 2007 2009: Housing wealth declined further $1 trillion 2010: Some experts predicting further drop of $1.7 trillion Collapse => Recession, turmoil in financial markets

11. Financial Market Melt Down In 2008, many homeowners ‘underwater’ Delinquency rates and foreclosures rose sharply Value of MBS and related derivatives dropped precipitously Market for these securities collapsed Insurers (e.g., AIG) could not make good on credit default swaps Many instruments, institutions exposed to losses Investors had little confidence in financial instruments Led to credit squeeze that hit financial markets in 2008 Bankruptcy of Bear Stearns, liquidation of Lehman Brothers Near death experience for AIG, Goldman Sachs

12. Job Market Crisis Worst Jobs Crisis Since Great Depression Unemployment hit 10% Oct. 2009, still very high Dec. 2010 post-depression record: 20 months > 9% Unemployment + sub-employment = 25 million workers 40% (>6 million) jobless more than 26 weeks Lack of demand, not structural/skills mismatch Nearly 4 million missing workers – dropped out of labor force Job creation should be top priority – why the focus on the deficit?

13. Sharp Decline in Payroll Jobs

14. Millions of Workers Left Labor Force

15. Inadequate Policy Response By the fall of 2008, when Barack Obama won election : HHs had lost ~ $12 trillion of housing bubble, stock market wealth => Drop in consumption ~ $600 billion a year Residential construction falling at ~$450 billion a year Non-residential construction falling at ~ $200 billion annual rate Private sector demand down ~ $1.2 trillion (about 9% of GDP) Policy response: early but inadequate Bush TARP – bailed out banks, but no economic stimulus Feb. 2009, stimulus $784 billion over 2 years on party line vote Small relative to size of hole – in part, to get through Congress Also, econ advisers missed bubble, underestimated severity Over-promised results: public disappointed, confused

16. What About the Deficit? (Short Run) Deficit due to recession and fall in tax revenues -- There has been no explosive growth in spending Non-interest spending: 19.8% of GDP in 1980, 21.1% in 2011 Compare with ‘austere’ Germany; record high UK public sector deficit and net borrowing in Nov. – why both are still growing Tax revenue as % of GDP: >18% ave. 1970-2007, 14.8 % in 2009 America is not ‘going broke’ Unlike Ireland or Greece, US owes debts in currency it controls: $$ Will always be able to pay interest on Treasury debt Disinflation, not inflation, and low interest rates

17. Federal Tax Receipts as Share of GDP

18. Myth: German ‘Austerity’ vs. US ‘Profligacy’

19. What About the Deficit? (Short Run) Austerity is not the solution Premature fiscal consolidation will slow growth, reduce tax revenues GOP already calling for spending cuts to ‘pay for’ tax compromise Won’t achieve hoped for reduction in deficit During high unemployment, deficit need not be a burden Not inflationary when there are unemployed resources Fed can buy Treasury debt – return interest to Treasury Later, can raise bank reserves to unwind this policy

20. What About the Deficit? (Long Run) Long-term structural deficit (explodes after 2020): Driven almost entirely by explosion in per capita health care cost Government programs cover more than half of US health care costs US already pays twice as much as other wealthy countries with same or longer life expectancy – expected to rise further With per capita costs similar to other wealthy nations, US would have budget surplus, not deficit Note that Social Security does not contribute to the deficit By law, cannot pay out more than it has on hand

21. The Benefits of Controlling Health Care Costs

22. Close Deficit w/o Painful Austerity Measures Cut military expenditures for fruitless wars, unnecessary arms Eliminate corporate welfare Allow govt. to negotiate with drug companies on prices it pays Stop subsidies for oil and gas exploration, production Eliminate farm subsidies to big agro-business Reform tax code Enact financial transactions tax to discourage excessive speculation Tax dividends, capital gains, ‘carried interest’ as ordinary income Raise taxes on top 1% The “deficit-reduction agenda is an attempt to weaken social protections, reduce the progressivity of the tax system, and shrink the role and size of government …” Joseph Stiglitz

23. Digging Out Immediate policies with minimal impact on the deficit Right to Rent: Provide real assistance on home foreclosures Work sharing: Prevent layoffs, retain workers, preserve skills Card check, first contract arbitration: Make it easier to form unions Minimum of 7 paid sick days a year: So workers don’t lose their jobs if they or a child gets the flu National FML insurance – employee-paid: To provide income and improve job retention Raise minimum wage and index to half the median wage Require bailed out banks to use funds Fed now provides at near 0% interest to lend to credit-worthy small businesses on favorable terms

24. Worksharing => Smaller Rise in Unemployment

25. Digging Out Returning financial sector to pre-crisis profitability did not translate into robust growth and jobs Economy needs more stimulus, done well Government spending has to fill the gap in private demand HHs need to pay down debts and they are –> Can’t increase spending Maximum bang for the buck: Extended UI benefits, increased food stamps Refundable tax credits for low and middle income households Invest in America’s future (now, while interest rates are low) –> High return public I increases deficit in short run, reduces it in long run

26. Conclusion Short run: Choice is simple – more stimulus or persistent high unemployment Recession, financial crisis due to incompetent economic management Appears that workers and their families will be forced to suffer for years into future because of continued mismanagement Long run: Great recession, financial crisis exposed downsides of US model Debt-financed consumption and economic growth are unsustainable Not a substitute for wage–led growth (in line with productivity growth)