Recovery Lags Other Recessions

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Jan. 27, 2012, 2:48 p.m. EST

Economic recovery is still threatened

Commentary: Tax cut, jobless benefits needed to support consumers

By Adam Hersh

WASHINGTON (MarketWatch) — The U.S. economy picked up speed in the last quarter of 2011, but it is still hung over from the 2000s’ real-estate-bubble-driven economy, according to data released today by the Bureau of Economic Analysis. With our economic recovery still facing numerous risks, policy makers should continue soon-to-expire payroll tax cuts and unemployment insurance benefits to sustain growth momentum.

In the final quarter of 2011, U.S. gross domestic product, or GDP — the measure of all goods and services produced by workers and property in the United States — expanded at 2.8% annualized rate and now stands $96 billion larger than before the start of the recession four years earlier.

This marks the 10th consecutive quarter of economic expansion and the best growth performance for the U.S. economy since the height of the Recovery Act in early 2010. Read MarketWatch’s full coverage: Economy expands 2.8% in fourth quarter.

But beneath the surface of today’s headline growth figure, middle-class and low-income families’ financial stress, residual real estate weakness, and government fiscal contraction are taking a toll. Our economic health is much more fragile than the fourth-quarter growth suggests, and what drove growth this quarter is unlikely to sustain moving forward.

U.S. GDP rises 2.8%

The U.S. economy grew at its fastest pace in more than a year and a half in the final three months of 2011, rising at an annual rate of 2.8%. Kathleen Madigan reports on the Markets Hub.

Consider that nearly two-thirds of the overall increase in GDP was driven by businesses restocking their inventories after depleting them earlier in the year. The next-largest contributor to growth in the fourth quarter came from households, who cut back on saving in order to spend more on consumer goods.

But with household indebtedness exceeding 114% of after-tax income, consumers will eventually be forced to boost saving and reduce consumption. Cutbacks on public investments and services are likely to further reduce demand at present and along with that the foundation of longer-term private sector growth.

There are also some bigger picture concerns. Comparing the experience of consumption and investment through the current business cycle with the experience on average in previous post-World War II recessions makes clear that the post-bubble debt-overhang we now face distinguishes this recovery from most others. (See the charts at the top of this article.)

It’s true that consumer spending by households, the single-largest component of the U.S. economy, increased at a 2% rate in the past quarter. It’s now up 1.5% over pre-recession levels. But compared to previous recessions, the recovery of household consumption looks markedly weak. At this point in past business cycles, consumption on average had increased nearly 14%.

And the slow growth of consumption actually understates the financial stress faced by households: Despite growing in aggregate, personal consumption is actually 1.4% lower on a per-capita basis than four years ago. Without critical social safety net programs, it would be even lower.

The persistently weak residential real estate market is further adding to the financial stress on families. Whereas in typical recessions residential investment tends to lead the recovery, up 23% on average at this point in the business cycle, at present it is languishing more than 45% below its pre-recession level. With home prices yet to stabilize in most regions, owners coping with overvalued mortgage payments, and one in eight mortgages in foreclosure or delinquency, resolving weakness and uncertainty in the real estate market are central to boosting both household consumption and residential investment.

The economy is clearly not working for all Americans, either, with 13 million unemployed workers and countless middle-class and low-income families struggling financially. The gap left in consumer demand by financially stressed families is restraining private business growth and investment, as well. For a time, the Recovery Act and related increased public investment, services, and tax cuts helped fill the hole in demand. But in each of the past four quarters government fiscal contraction slowed economic growth by more than half a percentage point on average.

Small-business owners surveyed by the National Federation of Independent Businesses reported “poor sales” (i.e., lack of demand) as their number one problem for the past 40 months. With uncertain prospects for expanding sales, business investment, too, is far behind the pace of previous economic recoveries. Investment in equipment and software grew incredibly through late 2009 and much of 2010 in concert with Recovery Act investments and tax incentives, but slowed to 5.2% growth at the end of 2011, primarily in information technologies. Four years later, equipment investment is 3% above its pre-recession level, but it’s more than 12% behind the pace of previous recoveries. Insufficient demand also constrains business investment in commercial real estate and factories, which is down 35% since the start of the recession.

In addition to weak demand that hampers growth, numerous risks on the world economic horizon — Europe’s simmering banking crisis, slowing growth in China, and potential oil price volatility — threaten to blow headwinds against the still-fragile growth in 2012.

But perhaps the biggest threat to growth remains the home-grown risk of self-inflicted damage from continued political intransigence in Congress. American businesses, and the middle-class consumers on which they rely, will take a big hit if Congress fails to continue unemployment insurance benefits and payroll tax cuts for all working Americans, both set to expire in February.

Keeping this money in the pockets of consumers will help families to continue meeting their needs and give certainty to businesses about where their next sale will come from so they will hire and invest more.

Adam S. Hersh is an economist at the Center for American Progress,