In the first of a three-part series Larry Elliott and David Teather explore the economic recovery that never was
Oil prices are heading for $60 a barrel. Motorists in the United States are getting their heads round the idea of paying $2 for a gallon of gas. Eighteen months after the ousting of Saddam Hussein was supposed to put the skids under the cost of crude, you might imagine America’s reliance on imported fuel would be a crucial issue in the race for the White House. It isn’t.
America is racking up trade deficits of $50bn a month and anger is growing out in the industrial heartlands about China’s refusal to revalue its currency. Yet trade policy is a peripheral issue as George Bush and John Kerry enter the last week of campaigning.
You have to go back as far as Herbert Hoover to find a president with a worse record on jobs than the incumbent and poverty is on the increase in the world’s largest economy. The stock market, which boomed under Clinton, suffered under Bush as a result of the dotcom boom’s collapse, recession and a string of corporate scandals, as the chart above shows. Yet, if you listen to the candidates and monitor the media, jobs are not the real issue.
What matters in this election is the fitness or otherwise of Bush or Kerry to be commander in chief. It is about who has the “right stuff”, who can best defend the American homeland from terrorism, who can be trusted with national security.
By his attacks on Kerry’s integrity, Bush has avoided the problem his father faced when Bill Clinton persuaded voters that the economy was what mattered, not the victory over Saddam in the first Gulf war. If there was ever an election where “it’s the economy, stupid” mattered, then this should be it. But that is not the case. As Mark Granakis, a branch president of the steelworkers’ union in Ohio, puts it: “Franklin Roosevelt told us the only thing we had to fear was fear itself. This president says: ‘Be afraid’.”
That Bush has to campaign in this way, more like a challenger than the incumbent, is a sign of weakness, not strength.
Consider the evidence. The statistics suggest that the economy has done well under Bush. After all, he came into office at a difficult time: the economy was heading south as a result of the dotcom bust and, just as there were signs that it might be on the mend, along came 9/11. What is more, the president can argue that the recession was short and shallow. The figures for growth out this week are expected to show the economy expanding at an an nual rate of about 4%. America has comfortably outpaced Europe over the past four years, but that says more about the weakness of Europe than the underlying health of the world’s largest economy.
In comparison to previous US economic cycles, the recovery has been weak. In the first 10 quarters of the upturn, annualised GDP growth averaged 3.4% In previous recoveries it averaged 5.4%. Over the same period, real wages and salaries rose at an annualised rate of 2.2%, way below the historical average of 10.6%. And there are fewer Americans in employment than when the upturn started.
“The jobless recovery since 2001 has created greater economic problems for Americans than the sluggish job performance of Europe in the 90s created for Europeans,” according to Richard Freeman and William Rodgers in their analysis of what has gone wrong with the great American jobs machine. “The United States has only a limited safety net for workers. Those who lose their jobs risk losing healthcare or seeing their family drop from the middle class into poverty. American welfare policy is full employment, not a social welfare state.”
Predictably, then, the failure to generate the number of jobs normally associated with an American economic recovery has seen an increase in the number of people living below the breadline. Poverty has risen and there are now 44 million Americans without health insurance.
What may appear puzzling is that this has been accompanied by an increase in the share of the economy accounted for by consumption – which stands at a record level – and by a hefty increase in the trade deficit. If workers are not seeing real incomes rise very much, how come they are spending as though it’s going out of fashion?
The answer is that individuals have not just spent their tax cuts but been encouraged to borrow by the loose monetary policy of the Federal Reserve. “Provided you’ve got a pulse, the banks here will lend you money,” said Steve Newman, head of an organisation in Cleveland that seeks to find work for the unemployed.
Domestic demand has been kept going by an unprecedented explosion in credit. Alan Greenspan has pumped trillions of dollars into the economy, and the extra liquidity has boosted asset prices. The stock market has recovered ground lost after 9/11 and the housing market has boomed. Consumers have remortgaged at low rates and simply carried on spending.
There is an obvious limit to pumping up demand in this way and the US has reached it. The Fed is starting to raise rates in an attempt to reverse the decline in saving, and this heralds the end to the remortgaging boom. For the time being, households are trying to stave off the inevitable by increasingly plumping for variable rate products, which on average have interest rates two points below fixed rate products, but there have been signs in recent months that the squeeze on real incomes is having an effect.
Fiscal policy has been expansionary, but in a spectacularly unhelpful way. Bush’s tax cuts have helped those who are already rich. One example: America’s lowest 20% income earners are paid an average $12,000 (£6,500) a year. This year’s tax cut would have put an extra $2 a week in their pockets. For the top 1%, the news was better. Already on more than $500,000 a year, they would have received an additional $39,000 from the government. Yet the poor person is much more likely to spend an additional dollar than a rich person. Economists call this a higher marginal propensity to consume, but it is really common sense. If you’re on the breadline, you use an extra dollar to buy food or a new pair of shoes. If you’re on $500,000, you already have everything you need, so you bank the tax cut.
The counterpart to the US trade deficit is that countries in Asia – particularly China – are running huge surpluses. If America is consuming too much, China is investing too much. In the short term, this keeps prices of US imports low, but at the long-term expense of costing America jobs and of building up a colossal speculative bubble that will collapse as soon as the US takes action to reduce its trade deficit.
Received wisdom is that the US economy is on the mend and the recovery – in Greenspan’s words – will get traction. On this score, Bush is a classic Keynesian, using expansionary monetary and fiscal policy so the US can spend its way out of recession.
An alternative view is that the economy has been grotesquely mismanaged over the past four years, as witnessed not just by the trade deficit and the job losses but the way Bush has squandered the budget surplus bequeathed by Clinton.
There is a third perspective. It is that Bush has finally buried the Republican party’s reputation for fiscal prudence in favour of an approach to policy-making that dovetails with the conservative social views of his base. Michael Wolf wrote in the Spectator: “The Republicans are the party of the Southern Baptist Conference. The Democrats are the party of Goldman Sachs.” Kerry supporters such as Professor James Galbraith think this view is wrong. Bush, he says, doesn’t have and never has had an economic policy other than to “serve his clients”.
The shortcomings of this approach are becoming evident. Over the next two days we will be looking at what they are.