By Lawrence H. Summers
The opinions expressed are his own.
Even with the massive 2008-2009 policy effort that successfully prevented financial collapse and Depression, the United States is now half way to a lost economic decade. Over the last 5 years, from the first quarter of 2006 to the first quarter of 2011, the U.S. economy’s growth rate averaged less than 1 percent a year, about like Japan during the period when its bubble burst. At the same time the fraction of the population working has fallen from 63.1 to 58.4 percent, reducing the number of those with jobs by more than 10 million. The fraction of the population working remains almost exactly at its recession trough and recent reports suggest that growth is slowing.
Beyond the lack of jobs and incomes, an economy producing below its potential for a prolonged interval sacrifices its future. To an extent that once would have been unimaginable, new college graduates are this month moving back in with their parents because they have no job or means of support. Strapped school districts across the country are cutting out advanced courses in math and science and in some cases only opening school 4 days a week. And reduced incomes and tax collections at present and in the future are the most important cause of unacceptable budget deficits at present and in the future.
You cannot prescribe for a malady unless you diagnose it accurately and understand its causes. Recessions are times when there is too little demand for the products of businesses, and so they fail to employ all those who want to work. That the problem in a period of high unemployment like the present one is a lack of business demand for employees not any lack of desire to work is all but self-evident. It is demonstrated by the observations that (i)the propensity of workers to quit jobs and the level of job openings are at near-record low levels; (ii) rises in nonemployment have taken place among essentially all demographic skill and education groups; and (iii) rising rates of profit and falling rates of wage growth suggest that it is employers, not workers, who have the power in almost every market.
I belabor the idea that lack of demand is the fundamental cause of economies producing below their potential because the failure to recognize the centrality of demand can have catastrophic consequences. But for Hitler and the military buildup up he caused, FDR would have left office in early 1941 a failure, with American unemployment above 15 percent and with the recovery promise of the New Deal shattered by the premature attempt in 1937 to reassert the traditional virtues of deficit reduction and inflation control. When I entered the Clinton administration in 1993, it was generally believed that Japan had the potential to grow its economy by 4 percent a year going forward, enough to have doubled output from that time until now. Instead output has barely grown, a consequence of the post-bubble stagnation that Japan suffered.
A sick economy constrained by demand works very differently than a normal one. Measures that usually promote growth and job creation can have little effect or can actually backfire. When demand is constraining an economy, there is little to be gained from increasing potential supply. In a recession, if more people seek to borrow less or save more, there is reduced demand and hence fewer jobs. Training programs or measures to increase work incentives for those with both high and low incomes may affect who gets the jobs, but in a demand-constrained economy will not affect the total number of jobs. Most paradoxically, measures that increase productivity and efficiency, if they do not also translate into increased demand, may actually reduce the number of people working as the level of total output remains demand constrained.