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released) that will continue to thwart the competitiveness of the United States in world markets and put back to work “out-of-date” plant, machinery, and labor.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.

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.