The Progress of the Economic Recovery in the United States

The United States economy is growing.  However, the United States economy is not growing very fast and the growth does not appear to be very deep.  

January figures for Industrial Production were released today and about all one can say about the numbers is that the rate of growth is positive but modest.  And, the rate of growth seems to be declining. 

Year-over-year, industrial production grew at a 3.4 percent annual rate in January 2012. 

However, this is down from a 3.9 per cent, year-over-year, rate of growth in the fourth quarter of 2011 and down from a 6.2 percent, year-over-year, rate of growth in the fourth quarter of 2010.  In the fourth quarter of 2009 the economy actually declined by 5.5 percent, year-over-year. 

The numbers for industrial production are not inconsistent with the pattern of growth, year-over-year, of real Gross Domestic Product.  In the fourth quarter of 2011, the year-over-year rate of increase in real GDP was 1.6 per cent.  In the fourth quarter of 2010, the similar measure stood at 3.1 percent.  For the fourth quarter of 2009, like the figure for industrial production, the economy actually declined by 0.5 per cent.

Looking at the numbers in this way does not give one the upbeat feeling one can often get from just looking at the month-to-month change in the numbers.

Furthermore, information on the capacity utilization of industry (also released today) and the under-employment of working age people still indicates that there is a massive problem in our use of physical capital and of human capital. 

Capacity utilization in manufacturing stands at 78.5 percent in January.  That is, more than 20.0 percent of our industrial capacity is standing idle!  The important thing to me here is that the capacity utilization in the United States has been on a downward path since the 1960s.  Please check the chart below. 

Reading the chart from the left to the right shows a dramatic downward trend with each subsequent peak in capacity utilization being lower than the one previous to it. 

The question that remains to be answered is whether or not the trend will be continued with the “peak” in capacity utilization we are going to reach this time around.

The United States has a growing mis-match in the industrial capacity it has built and the industrial capacity that is useful.  This mis-match must be worked off…there is not an over night solution to this problem.

The same situation exists in the labor markets.  The under-utilization of working age people has grown since the 1960s.  In the 1960s about one in eleven or twelve people in the United States were under-employed.  The measure of under-employment now stands somewhere between one in four or one in five people that are of working age. 

The United States has a major problem.  Jobs and industrial capacity are not matched with the present makeup of our human and physical capital.  These under-employed persons and this under-utilized plant and equipment are not going to be matched up any time soon.  Thus, under-employment of labor and under-utilization of industrial capital are going to be around for a long time.  And, the rates of economic growth we are experiencing will not do much to help the situation.

The Economic Picture--No Steam Ahead!

The August unemployment rate was 9.1 percent.  Not much joy in Mudville.

About one in five Americans in the prime age for working range remain under-employed. 

We have the short-run problem related to economic growth and the fact that families, businesses, and governments need to get their balance sheets in order before they will really begin to spend again. (http://seekingalpha.com/article/290934-struggling-with-a-great-contraction) 

We have the long-run structural problems in the labor market related to the fact that the skills of many individuals of working age do not mesh with the jobs the economy is creating or is going to create.  For a dismal picture of this situation see the recent article in Bloomberg Businessweek (August 29—September 4, 2011) titled “The Slow Disappearance of the American Working Man.” 

And short-run growth seems to be going nowhere.  Just look at the year-over-year rate of change in industrial production.  Note that this series peaked in the second quarter of 2010.  The modest decline in this growth rate has now been going down-hill for more than 12 months.

Of course, the performance of industrial production is also captured in the year-over-year growth rate of real Gross Domestic Product.  Here the peak growth rate was achieved in the third quarter of 2010.  The growth rate has declined since.

If the economy fails to grow by 3.0 percent or more, jobs will not be added at a rate that will lower the unemployment rate.  And, growth at this rate will certainly not resolve the long run problem related to those that are holding part-time positions that would like to have full-time jobs and those people that have left the work force. 

Furthermore, this scenario is not one that is favorable to people making much headway in reducing the burden of their debts.  Thus, the “debt overhang” seems to be a part of the continuing saga of our economic malaise.  The environment for getting out of debt does not exist.

Given this picture, the questions that arise pertain to the concern that America may face a decade like Japan has faced or a decade like that in America in the 1930s.  Maybe this is the “payback” for the period of credit inflation we have experienced over the past fifty years.  Maybe the only way out of this situation, which is not a short-run solution, is to focus on the fundamentals, focus on the structural problems created over the past fifty years.

The Federal Reserve, so far, has acted so as to prevent another “shock” to the economy like the one they introduced in the 1937-38 period.  In this earlier period the Fed caused banks to become even more restrictive in their lending operations than they had been and this precipitated a second depression for the 1930s.  This time the Fed has flooded the banking system with liquidity and seems to be in no hurry to remove anything that appears excessive in terms of bank reserves even though bank lending remains modest, at best. (http://seekingalpha.com/article/290416-quantitative-easing-theory-need-not-apply)   

The short-run conflict that is going on right now is between the efforts of the Federal Reserve to stimulate bank lending and the financial system, and the efforts of families, businesses, and governments to reduce their debt loads.  At the present time, the latter interests seem to be winning.

The longer run question relates to whether or not the government stops focusing just on short-run solutions to the problems of the economy and begins to focus on the longer-term structural problems that exist.  The difficulty here is that it took a long time to get where we are now and it can be expected that it will take us a long time to get things back in order. 

The real dilemma is that we don’t create more problems for the future by implementing short-run solutions to our problems that will just exacerbate our longer-run problems.  In the long run we may all be dead, but we now seem to be dealing with the long-run problems left to us by earlier generations of policy makers that just focused on short-run solutions without any regard for the long run!

Why Debt Is Going To Continue To Be A Problem In The United States

Officials at the Federal Reserve and in many other leadership positions around the world believe that liquidity is the solution to our current woes. And, if the amount of liquidity that is in the anking and financial markets is not enough to resolve our problems then more liquidity is certainly the answer.

This is behind QE2, and this is behind most of the effort to resolve the sovereign debt crisis in Europe.

What does liquidity allow you to do? It allows you to sell assets into the marketplace.

However, selling assets into the marketplace does not solve your problems if the price at which you sell the assets is substantially below the accounting value of the assets on your balance sheet. In such cases, having liquid markets in which to sell assets may allow you to more than wipe out your equity and leave you unable to pay off your debts.

There are two ways to counter this problem. The first is to inflate prices so that the real value of the debt declines which reduces the amount of leverage you have on your books. The second is to create income and wealth so that equity increases relative to the debt outstanding thereby reducing leverage.

The people advocating the injection of more liquidity into the financial system hope to spur bank lending and thereby stimulate economic growth. Those that are concerned with the creation of more and more liquidity argue that this first group of people really just want to create inflation and reduce the real value of the debt.

The problem I see unfolding is that the economy is expanding and will continue to expand in 2011, but it will not expand in such a way as to stimulate sufficient income growth and wealth creation so as to lower the debt loan many people are bearing. As a consequence, the further liquefying of the banking and financial markets will just benefit those who are not too highly leveraged…generally the financially better off in society…and continue to depress those who are highly leveraged.

In terms of economic growth, the economy is expanding. However, by historical standards, the year-over-year rate of growth of real Gross Domestic Product is substantially below the general recovery pattern. In the year-over-year rates of growth in 2010 were 2.4%, 3.0%, and 3.4% in the first, second and third quarters, respectively. Historically, at this stage of the recovery, the growth rates are usually much greater.

The problems come when we observe some very basic facts with respect to economic performance. First, although Industrial Production has recovered from the lows reached during the recession it has not come close to reaching the peak it attained before the recession set in. Second, the capacity utilization of our manufacturing has recovered, yet it still lies well below its previous peak (which is the lowest peak achieved since the statistical series was begun in the 1960s). Finally, even though unemployment dropped last month, under-employment continues to be extremely high as I estimate that one out of every four or one out of every five individuals of employment age are either unemployed, working part time but would like to work full time, or have dropped out of the work force. This phenomena is captured in the data on the Civilian Participation rate. Note, that this rate is substantially below the level it was before the Great Recession began in December 2007 and is also even further below the level reached before the 2001 recession. Under-employment in the United States has been growing, almost steadily, since the latter part of the 1960s.

Even though corporate profits are rising dramatically, even though many large corporations are acquiring other corporations at a very rapid pace, even though commodity prices are going through the ceiling, even though the big banks are doing very well, thank you, there seems to be a real structural problem in the United States. Liquidity is helping a lot of people but it is not the people we are talking about in this

Let's Look at the United States rather than Europe for a change

Durable goods orders are up 2.9% in April. New home sales rose last month. More and more statistical releases point to a continuing recovery. More and more it appears as if the Great Recession did end in July 2009 and we are, consequently, in the tenth month of the economic upturn.

However, it still doesn’t quite feel like much of an upturn. But, economic pundits contend that there is very little chance for a “double-dip” recession even with the financial turmoil rocking Europe. One analyst argued that with the European disorder the probability of having a “double-dip” recession has risen, but from about 5% a month earlier to around 20% now. In other words, he believed that it is highly unlikely that we will have a “double-dipper.”

My concern is still focused upon the long-term fact that there is so much un-used capacity in the United States. The efforts to stimulate the economy, as a consequence, represent efforts to put people back into “legacy” jobs (the jobs from which they were released) that will continue to thwart the competitiveness of the United States in world markets and put back to work “out-of-date” plant, machinery, and labor.

If we look at capacity utilization in the United States, we see that we are using more capacity now than we did in July 2009. For April the figure was below 73.7%. However, we are still substantially below the previous peak in capacity utilization, which came in at about 81.5% in 2006. And, the previous peak before that was below the previous high before that, 85% in 1997, which was lower than the previous peak and so forth for the whole post-World War II period.

Furthermore, industrial production remains depressed from the level it attained in early 2008 and also in 2000. Both series are making progress, but we are still running way below levels that were previously attained and although the “catch up” seems to be robust, the question remains as to whether or not these measures will exceed earlier highs in the near future.

Adding to this concern is the fact that the labor situation remains weak. Unemployment in April stayed just under 10%, but the number I am very concerned about is the total amount of workers that are under-employed. I am concerned, not only with those that are out-of-work, but those that are not fully employed but want to be fully employed, the discouraged who have left the workforce, and the people that have taken lower positions, positions that they can fill but are fully qualified to perform in other more challenging jobs. My estimate of these under-employed persons runs around 25%, about 1 out of every four people who could be considered to be in the labor force.

The fact that these factors are running so low relative to “capacity” employment raises concerns about the United States achieving its “potential” any time soon. To examine this possibility we look at a comparison between the estimates of the Congressional Budget Office of potential real Gross Domestic Product and the level that real Gross Domestic Product was actually attained. Not only was the United States economy producing at a level of output only 94% of potential, the rates of growth of actual real GDP seem to lie below the rate at which the CBO is estimating that potential real GDP should grow.

The economy of the United States is recovering, but one can understand why many people really do not seem to be experiencing it. Nothing in the previous stimulus plan, or in the one being developed, or in the current stance of monetary policy, gets the United States back on track. Different types of policies are needed to renew the productive capacity of the United States so that the U. S. can become fully competitive again and fully use its resources…both human and physical. Unfortunately no one seems to be working on these kinds of policies because they rely so heavily on the private sector. Also, these policies take too long to achieve results; politicians have a much shorter employment cycle.

Excess Capacity and the Slow Economic Recovery

Ben Bernanke spoke in New York yesterday and, depending upon which paper you read this morning, he basically said one of two things. First, he said that the Fed was interested in a strong dollar and would continue to keep the value of the dollar in mind in deliberations concerning monetary policy.

Chuckle, chuckle.

Second, Bernanke said that the pain in the labor market was going to last for a long time and that we shouldn’t expect the unemployment rate to fall anytime soon.

That is, don’t expect interest rates to begin to rise in the near future.

Remember, the number one policy goal of the Federal Reserve (and the federal government) is full employment and don’t you forget it. Put inflation, commodity prices, and the value of the United States dollar on the back burner.

So much for an independent Fed!

But, we knew that.

The problem with the economic recovery and unemployment is captured by an article in the Wall Street Journal, “Auto Industry Has Room to Shrink Further,” (see http://online.wsj.com/article/SB125832250680149395.html?mg=com-wsj.) Although the article focuses upon the auto industry, the situation that is described can be extended to many other major (and minor) industries throughout the world.

“Over the past two years, the global auto industry has endured one of the worst downturns in its century-plus history. Auto makers around the world have consolidated, restructured and slimmed down—and yet they still have too much of just about everything, especially too many brands and too many plants.”

“According to CSM Worldwide, the auto industry has enough capacity to make 85.9 million cars and light trucks a year—about 30 million more than it is on track to sell this year, the equivalent of more than 120 assembly plants.”

Furthermore, an auto analyst is quoted as saying, “government intervention to save auto-related jobs has forestalled the inevitable—broad and deep restructuring that would shut down unneeded plants and close loss-making enterprises. Not as much capacity has come out that should have.”

This is just talking about the auto industry. But, it is true of industry in general. The United States and the global economy have become leaner due to the current contraction: still, much excess capacity remains.

Even though capacity utilization for all industry is up in the United States (note that capacity utilization for manufacturing in October did not change from September), giving further indication that the recession is over, the problem of too much capacity lingers. As I have mentioned many times before, every economic recovery since the 1960s has seen a pickup in capacity utilization as economic growth increased, but the peak reached in each cycle was no higher, and was generally lower, than the peak reached in the previous cycle.

That is, capacity utilization rose during the expansion phase of each economic cycle since the 1960s but the trend in the United States was for more and more plant and equipment to remain idle.

In addition, this contributed to the under-utilization of labor as is evidenced by the rising trend in those of the population that are labeled underemployed .

Also, as the federal government, and the independent Federal Reserve System, tried to pump up the economy so that fuller employment could be achieved, the pressure was always on for inflation to rise. Since January 1961, the purchasing power of the dollar has fallen by about 85%. This is not a coincidence!

Furthermore, these policy efforts just put people back to work in the jobs they had been in and reduced the incentive for companies to innovate and change moderating productivity growth.

The performance of industrial production in the United States carries with it the same story. (Industrial production is up in October, but at an anemic 0.1% rate.) The growth rate of industrial production rises and falls through the swings in the economic cycle, but each rebound does not bring with it the same expansion as was achieved in previous cycles. This is just another indication that although recovery takes place, the overall trend in the productive utilization of resources in the United States continues to wane.

This fundamental weakness resource utilization is resulting in changing attitudes throughout the world. David Brooks writes in the New York Times about the underlying optimism that seems to be present in China these days, an optimism that used to be present in the United States. Simon Shama writes in the Financial Times about how China is now “wagging its finger at the United States about it wayward monetary and fiscal policies, as yet, still unaccustomed “to being the strong party in the relationship.” Clive Crook, also in the Financial Times, writes about the looming political battle in the United States concerning the “big questions” that voters have to answer “about the entitlements they demand and the taxes they are willing to pay.”

The United States is strong and will continue to stay strong. But, its relative position is changing. And, the way its leaders go about attempting to resolve problems is missing the point.

The United States economy is recovering. But, unless policy prescriptions change, there will continue to be an under-utilization of capacity, a weakness to productivity growth, a bias towards inflation, further declines in the United States dollar, and the threat of protectionism.

It is said that people and a nation do not change their habits until there is a real crisis. Right now it looks as if we have wasted a pretty significant financial crisis in returning to our old ways and old policy prescriptions and will just have to be content with an economy that produces mediocre results. No one seems anxious to change how we attack our problems.

The State of the Economy and Supply Side Concerns

Several of the aggregate economic indicators are indicating that the economy has bottomed out. Industrial Production seems to have hit a bottom in June 2009 as the year-over-year rate of decline on a seasonally adjusted basis was -13.3%. Since then the negative rates of growth have fallen: in August the rate of decline was -10.4% and in September this rate dropped to -6.1%. The index has actually increased, month-over-month, beginning in July.

The decline in real Gross Domestic Product (GDP) lessened in the third quarter this year on a seasonally adjusted year-over-year basis. The greatest year-over-year decline came in the second quarter of 2009 when real GDP fell at a 3.8% annual rate over the second quarter of 2008. The first look at the third quarter number is to be released on Thursday. According to the Wall Street Journal, estimates for the third quarter over the second quarter annual rate of increase stand at a positive 3.1%. If this quarter-over-quarter rise takes place, the year-over-year rate of decline for the third quarter of 2009 will be -2.4%.

On the surface, it does look at this time as if the third quarter of 2009 will be declared the beginning of the economic recovery in the United States.

That is the good news.

The not-so-good news, to me, is the extent of the recovery. There are some areas we need to keep our eyes on in order to help us understand what is going on in the economy. These are the “supply side” conditions that indicate something else is happening in the economy other than just an economic recovery. They are conditions that tell us that some economic dislocations exist that will have to be resolved in the future if the United States economy is going to become robust once more.

The first of these areas has to do with our manufacturing capacity. Capacity utilization in September of this year stands at 70.5%, up from the trough of about 68% in June. So, capacity utilization has begun to increase.

The problem is that this capacity utilization is at a post-World War II low! But, even more important is that the previous peak in capacity utilization came in the 2005-2006 period but was just over 80% at that time. And, this peak was down from the 85% capacity utilization of the 1995-1997 period and the 1988 period. And, these peaks were down from the 87% capacity utilization of the 1978 period, which was down from the 89% rate of the 1974 period and the 90+% of the middle 1960s.

The United States has seen over the past forty years or so a deterioration of its industrial base. There is a lot of idle capacity that is in place but, for various and sundry reasons, is not being used. We can address some of these reasons in forthcoming posts. The important concern to me is that in the economic recovery we will not even us get back to the 80% range of capacity utilization. The implication of this is that unemployment will not fall as much as we would like and that business investment spending would not be very robust because firms won’t need manufacturing capacity, they already have it.

This would lead one to the conclusion that business spending will not be too strong in the recovery. But, it is a supply side problem, not a demand side problem.

And, speaking of employment, there is an unused capacity problem as far as the labor market is concerned. The official unemployment rate, the total unemployed as a percent of the civilian labor force, stood at 9.8% in September 2009. The rise over the last year is from 6.0% in September 2008.

The total unemployed, plus all marginally attached workers, plus total employed part time for economic reasons, as a percent of the civilian labor force plus all marginally attached workers is 17.0% in September 2009 up from 10.6% in September 2008. That is, there has been a substantial increase in persons who are neither working, nor looking for work but indicate that they want a job and are available, discouraged workers and people working part time who would like to work full time.

There is a lot of unused capacity in the population as a whole. From everything we are hearing, the marginally attached and the discouraged do not have too much to hope for in the upcoming economic recovery and this doesn’t even consider the expected rise in the official unemployment rate.

The conclusion one can reach from these data is that whatever has been going on in the United States for the past 40 or 50 years has not been totally healthy for the supply side of the economy. Basically, the past 40 or 50 years has seen a lot of inflation. Since January 1961, Consumer Prices in the United States have risen by 625%, or, in other words, the real value of a dollar has decline by 86% since then.

One could easily make the argument that whatever went on in the United States over this period, it was a period of extended inflation and that such an environment was not the most productive one for economic resources. This environment resulted in a lot of unused productive capacity, in terms of physical resources but also in terms of human resources.

Current policy is doing what has been done consistently in this period, emphasized a demand side bias. An inflationary policy, created using fiscal and monetary policy to stimulate aggregate demand, has been the response to the economic slowdown. And, the policy attempts to achieve higher rates of employment by putting resources back to work at their old functions. Of course, this cannot be fully achieved as technology and other efficiencies allow new jobs to be created that do not use the old skills, or old jobs to be eliminated and excess capacity to grow. Thus, capacity utilization continues to drop and those in the workforce that are discouraged from seeking a job remain unfulfilled.

A Walk on the Supply Side

Keynesian demand-side economics still rules the minds of the policy makers in Washington, D. C. Their actions and their analysis continually point to their focus on aggregate demand and the “green shoots” that are expected to accompany an economic recovery based on the stimulus of spending.

For over a year I have been arguing that more attention needs to be given to the supply side of the equation. Yes, the growth rate of real GDP has been going down and the rate of employment has been going up. But, the rate of inflation, as measured by the rate of increase of the GDP price deflator has not declined since the fourth quarter of 2007. If it were just a demand side problem, this would not be the case.

I focus on the rate of increase in the GDP implicit deflator because of some of the measurement problems associated with the Consumer Price Index, such as the treatment of housing expenses and energy. Certainly, the CPI should be watched, but in dealing with economic aggregates, I prefer the former.

My point has been that if the problems in the economy were all tied to a substantial fall in aggregate demand, then there should have been a more substantial lessening in the rate of price increases. Consequently, my argument has been that something has happened on the supply side of the economy for the numbers to have been reported as they have been.

I would like to point to two areas of the United States economy that indicates that the problems of recovery may be more difficult to overcome than if the dislocation in the economy were just one of inadequate aggregate demand. The first area is that of industrial output; the second area is the labor market.

In terms of the industrial base of the economy I would like to focus upon industrial production and the industrial utilization of capacity. Industrial production has been declining steadily since the start of the recession in December 2007. At that time, industrial production was growing at about a 2.0% year-over-year rate of growth. By April 2008 the year-over-year rate of growth had become negative. The figures for 2009 are
January -10.8
February -11.3
March -12.6
April -12.7
May -13.4

This certainly shows a continuing weakening in the economy. However, taken by itself I don’t think that it carries more meaning than does the decline in the rate of growth of real GDP which has been declining as well.

Combine this performance with the figures on capacity utilization and one gets a different picture. As expected, total industry capacity utilization has dropped substantially in this recession. In December 2007, the figure stood at a little over 80.0%. In May 2009, capacity utilization had fallen to about 68.0%. This is the largest 18 month decline in the post-World War II period.

But, this is not all. The peak in capacity utilization in the past ten years was only slightly more than the December 2007 figure. But, this peak of the last ten years was substantially below the level of capacity utilization for most of the 1990s which was below the peak utilization in the 1970s which was below the peak utilization in the 1960s. That is, it appears as if we have been using less and less of our capacity on a regular basis since the 1960s.

The structure of our industrial base is changing. We can see that in autos, in steel, and in many other parts of our manufacturing base. It appears as if the weakness in our economy is composed of two things: first the cyclical swing in business; but this weakness is on top of a secular decline in our productive ability. The economy is in the process of restructuring!

This shift is also showing up in labor markets. The civilian participation rate in the labor force for the United States rose from the late 1960s into the 1990s when it peaked a little above 67.0%. The civilian participation rate has declined since late 2000 and has remained below 66.2% since 2004. In terms of the number of people who are not participating in the labor market any more, this represents a large number. People have left the labor force in the last five or six years and this trend has, of course, been exacerbated by the recession. Over the past forty years the rise in the participation rate has slowed down or stopped during recessions, but at no time did it decline as it did in the in the past six years.

Of further interest, the Labor Department reported that separations from jobs in April remained relatively constant as they have for the past two years, but the rate of hiring continued to be quite low. In early 2008 the percentage of the labor force that were separated from their jobs was about equal to the percentage that were being hired. Since then separations have exceeded hirings, as might be expected, causing the unemployment rate to rise.

In terms of those that were separated from their jobs, there was a dramatic shift between those that quit their jobs and those that were laid off or discharged from their jobs. The percentage of layoffs and discharges rose dramatically from April 2008 to April 2009 whereas quit levels dropped substantially. That is, although separation rates did not change much at all during this time, the composition of those being separated from their positions experienced a tremendous shift. This is an indication that there is a structural shift in what is happening in the labor markets.

This information leads me to believe that there is a substantial restructuring taking place in the United States economy. And, a structural shift is a supply side issue and not a demand side issue. In fact, demand side responses can just make a bad situation worse by trying to force people back into positions that companies and industries are attempting to eliminate because the world has changed.

The figures on industrial production and capacity utilization seem to indicate that industry is changing and the numbers from the labor market reinforce that conclusion. Pumping up aggregate demand is an attempt to stop this restructuring or, at least, slow it down.

The problem that policymakers’ face is that they, or we, do not know what the new industrial structure is going to look like. It is impossible for anyone to know. People can make guesses, but that is all they are—guesses. And, in situations like this, it is more likely that the guesses will be wrong rather than being right. It’s just that the future is unknown. The need for the United States economy to restructure just adds another “unknown, unknown” to our list of “known unknowns” and “unknown, unknowns.” My guess is that this restructuring is going to take some time and could be sidetracked by huge government deficits and a supportive monetary policy.