Saturday, February 25, 2012
U.S. Economy Still Facing Many Obstacles to Recovery
Weakness in home building and state and local government spending are major obstacles to recovery, according to the annual Economic Report of the President.
While this is true, these are not the only obstacles the nation is facing as it struggles to rebound from the effects of the Great Recession.
New housing starts remain at roughly one-third of their long-term average levels. Without price stabilization and an uptick in housing starts, a stronger recovery of GDP will be difficult; residential real-estate construction accounted for 4 to 5 percent of U.S. GDP before the housing bubble burst.
Housing also spurs consumer demand for durable goods such as appliances and furniture, boosting the manufacture and sale of these products.
The housing bubble of the last decade gave a huge boost to all of these purchases. What people couldn't afford outright, they financed. And home equity was the primary resource.
From 2001 to 2007, families took advantage of easy credit to subsidize a national spending spree, often buying houses that have since fallen in value. Due to stagnant incomes, many families were only able to maintain their lifestyles by borrowing heavily against their homes.
From 2003 to 2007, US consumers extracted $2.2 trillion of equity from their homes. That amounted to an enormous economic stimulus, which is no longer available.
Excluding the economic impact of home equity extraction, real consumption growth in the pre-crisis years would have been around 2 percent per year — similar to the annualized rate in the third quarter of 2011, according to the McKinsey Global Institute.
This clearly illustrates just how reliant on home equity extraction the U.S. economy was in the previous decade. It was jet fuel for the nation's GDP.
However, consumers are now paying down all that debt, which is restraining consumption and economic growth.
Since consumer spending accounts for 70 percent of GDP, the economy will be held back as long as Americans continue paying off those accumulated debts, are limited by stagnant or falling wages, or are grappling with unemployment.
The annual report says that two million jobs will be created in 2012, slightly above the 1.8 million pace last year.
Such growth will be important to getting out of the enormous jobs deficit the nation is confronting. The government previously reported that 1.3 million jobs needed to be created every year from 2006-2016 just to keep up with the growing labor force.
Economic growth needs to be at least 2.5% to improve the nation's dismal unemployment situation. Anything lower won't even keep up with population growth. There are still 22 million Americans who are either unemployed or underemployed.
The president's report also projects that economic growth will accelerate to a 3 percent annual rate in 2012 and 2013, from a 1.6 percent rate over the four quarters of 2011.
The U.S. surely needs output of that magnitude. But it doesn't appear likely.
The nation's massive trade deficit shrinks GDP because we're consuming more from abroad than we're selling abroad.
And the federal government is about to embark on a major budget cutting initiative that is certain to shrink GDP. Over the past 15 years, or so, the economy became overly reliant on government spending to spur growth.
With all of that in mind, it's not a given that the economy will expand by 3 percent this year, much less in 2013, when most of the budget cuts will go into effect.
Moreover, almost all the states are still struggling economically and fiscally. Most continue to operate with significantly lower revenues and are still in the process of cutting spending. Austerity measures have led to a lot of suffering at the state level. Widespread state budget cuts are also reducing GDP and will continue to do so for the foreseeable future.
As I've said repeatedly, any sort of meaningful recovery is tied to housing and employment. Unless and until both rebound significantly, the rest of the economy will continue to lag.