Perspectives on the Current Economic Recession

World Growth is Reviving

The U.S. Share in the Global Economy Has Held Roughly at Twenty Percent

In Purchasing Power Terms, the U.S. Still Has the Highest Level of Per Capita GDP, but Danger Signs Abound

The Good News is that the U.S. is Still One of the Most Productive Economies in the World

And U.S. inflation rates have remained low, even though the risk of rising prices is growing

Moreover, while the latest recession has produced substantial increases in unemployment rates, the U.S. is better off than many other economies.

The misery index captures the twin measures of inflation and unemployment, with the U.S. still at the lower end of many major industrial economies

Now the downside of the U.S. Economy: While real household incomes have risen since the 1960’s, most of the increases have been in upper income households.

And Median income has grown the slowest among younger households in comparison to others. Younger households face rising child rearing expenses at a time when relative incomes are growing more slowly.

Slower growth in income among younger households translates in part to lower household equity, a key determinant in consumer spending.

If we exclude housing equity, the gap in median net worth by household age is even greater

Disparities in net worth are under growing pressure as age dependency ratios rise in major industrialized economies

With lower equity and income, younger households are experiencing a rising incidence of poverty, whereas older households have enjoyed a continuing decline.

In the aggregate, changes in income and household wealth are producing rising levels of inequality in the United States, surpassing those of the late 1920’s before the onset of the Great Depression.

Economic growth that could reduce poverty and income inequality has been hampered by mismanagement in the financial sector, with nonperforming loans accounting for rising default rates on mortgages and other forms of lending. Moreover, current incentives portend a return to the excess leverage that unfolded in the financial collapse that began in 2008

In the short-run, fiscal policy stimulus often exceeds monetary policy expansion in an effort to offset a recession. Yet tax receipts that would fund a fiscal stimulus tend to fall as overall GDP either slows in growth or moves in contraction. All of this generates a regular debate on the optimal size of government in the economy, and spills over into any given election cycle.

For the United States, not only is the size of overall government in decline. It also is in a reversion to state and local government displacing the role of the federal government. This pattern has not been seen since the late 1930’s when the Great Depression was still in force. Thus, nothing on the order of a federal government “New Deal” or “Great Society” is in the offing as a solution to the current recession.

What, if anything, is the relationship between the size of government and per capita income? If we look at a 2009 sample of 34 OECD countries, we find that the correlation between taxes and per capita GDP is weakly positive. That means that there is some positive association between the size of government and GDP. Yet the weak association suggests that incentives matter greatly as to the kinds of functions that governments undertake, with some governments doing much to foster economic growth while others create and prolong economic stagnation.

For the United States, it is clear that the overall size of government has been generally increasing since the 1920’s, with revenues as a ratio to GDP reaching a peak in the late 1990s. Ironically, this took place at a time when the U.S. economy was growing at significant rates, whereas the smaller size of government today has emerged as economic growth has declined. The key here is not that more (or less) government is the answer to economic growth, but what kinds of government incentives are needed to produce robust and sustainable growth over time.

If governments engage in deficit spending that does not produce an economic base from which job creation can unfold, debt levels not only increase but they weigh heavily on liquidity, and ultimately, the solvency of sovereign governments. Today, Greece is the poster child of an insolvent government, but the U.S. faces a rising ratio of central government debt to GDP that is unsustainable for the future. Thus while size matters, more importantly is what kinds of incentives are being applied.

Rising government deficits in the United States could not come at a worse time. When the economy is in recession, as it has been since 2008, ordinarily the use of deficit-based fiscal stimulus policies provide a short-term jump start to recovery. However, the U.S. has tried at least two of these programs, with economic recovery still at anemic levels in comparison to previous recessions.

What the U.S. now faces is a set of difficult fiscal policy adjustments, with the Congressional Deficit Reduction Committee looking to make over $1.2 trillion in reductions before mandatory formula-driven reductions take place. The question is whether any of these reductions will result in job-creating incentives that will revive the housing market, bank lending, and consumer an investment spending at rates that will bring the U.S unemployment rate back to historical levels while at the same time avoiding rising inflation. Unfortunately, the level of partisan politics in Washington is not likely to lead to an informed debate on these choices.