A host of commentators are arguing that the current U.S. slowdown – the most severe in a quarter century – is far from over and in fact destined to get much worse. The argument usually invokes a parallel with the Japanese recession of 1990. In Japan in 1990, real estate prices fell sharply after rapid increases over the previous decade, the stock market fell dramatically, and most large banks became either insolvent or very short on capital – all similar to what the US has experienced. And Japan subsequently went through a great-depression style slowdown in economic growth from which they have still not fully recovered.
While there are parallels between the US in 2007-2008 and Japan at the start of the 1990’s, there are also such vast differences that it seems hard to believe that the Japanese case, or our Great Depression of the 1930’s, are reasonable analogies for the current outlook. While one cannot know the future, let me provide three short comments on the main differences.
First, the initial declines in macroeconomic indicators are more consistent with the 1982-1983 U.S. recession than with either early-1990’s Japan or the U.S. great depression. To jog your memory, the unemployment rate peaked at 10.2 percent 16 months into the 1982 recession, and the current rate is “only” 8.9 percent. Now the 1982 recession was only 16 months long, but our recent macroeconomic numbers are leading most economic forecasters to predict recovery by the end of this year. Thus, it seems reasonable to expect a similar peak in the unemployment rate in this recession, rather than the 25 percent of the great depression. I expect that many pessimistic reactions to the current recession come in part from how different our current decline is from the stable economic growth we had become accustomed to in recent times. Since the 1982 recession, we have had only two brief and (relatively) mild recessions and the longest peacetime expansion followed by the longest expansion ever recorded in the U.S.
How much of our previous stability was due to luck or policy is still to be completely understood, but the policy responses to the current crisis are consistent with the second reason that I think we are in a recession and not the start of a depression. The US has undertaken massive and coordinated fiscal and monetary stimulus measures, to the point where it is hard to tell where fiscal policy ends and monetary policy begins. This is a good thing for ending the recession, provided of course we are able to return to balanced-budget policies in the near future. The risks for a more serious slowdown come not from the recession do far or from current large deficits, but from other long-term fiscal imbalances that have been looming on the horizon for decades, primarily pension and health care deficits. These problems haunt budgets at the federal, state, local, and even firm levels (and the federal government acts as insurer to firm pension funds).
The final reason that the US is not headed for a Japanese-style decade of lost growth is that the US economy has better economic fundamentals. The Japanese model worked well for much of the post-War period, but the economic-political structure had trouble dealing with the large changes that growth and then recession required. The US has relatively flexible capital and labor markets, so that when we stop building houses, workers (and equipment) find other lines of business. A great example of the Japanese approach is given in this article in the New York Times. Most Japanese firms do not fire workers but instead move them around to do other jobs when their old jobs are not productive. The article describes a sheet metal company that, when demand fell, started using its factory and workers to grow “parsley, watercress and other plants . . . staff tend the sprouts religiously, topping up the water supply, adding fertilizer and adjusting the fluorescent lights.” Is this the best use of these resources? Really? Might it not be better for these highly-skilled metalworkers to be out looking for other jobs and for this factory space to be for rent rather than being used as an indoor farm? To give some perspective, in the US from June to September 2008 (during the recession which began in December 2007), “the number of job gains from opening and expanding private sector establishments was 6.8 million, and the number of job losses from closing and contracting establishments was 7.8 million” (Source: Bureau of Labor Statistics). That is, during this recession, businesses have hired the equivalent of 4 percent of the labor force which, for comparison, is about the same percent as the increase in the unemployment rate during this recession. While unemployment is not good, the hiring is great. The risks for the US economy are not business as usual, but that in trying to end the unemployment, we eliminate the hiring. That is, our policies should not provide support capital and labor that should instead be finding employment elsewhere. At the moment, U.S. policies only have this flavor in the banking and automotive industries, and even in these industries there is significant elimination of jobs and the government is trying to get in and get out quickly. Thus, I expect that, while painful, we are in a recession not a depression.