A Tale of Two American Economies

NEW YORK – While the United States recently reported 3.5% GDP growth in the third quarter, suggesting that the most severe recession since the Great Depression is over, the American economy is actually much weaker than official data suggest. But official measures of GDP may grossly overstate growth in the economy as they don't capture the fact that business sentiment among small firms is abysmal and their output is still falling sharply. Third quarter GDP - properly corrected for these factors - may have been 2% rather than 3.5%.

The story of the US is, indeed, one of two economies.  There is a smaller one that is slowly recovering and a larger one that is still in a deep and persistent downturn.

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Consider the following facts. While America’s official unemployment rate is already 10.2%, the figure jumps to a whopping 17.5% when discouraged workers and partially employed workers are included. And, while data from firms suggest that job losses in the last three months were about 600,000, household surveys, which include self-employed workers and small entrepreneurs, suggest that those losses were above two million.

Moreover, the total effect on labor income – the product of jobs times hours worked times average hourly wages – has been more severe than that implied by the job losses alone, because many firms are cutting their workers’ hours, placing them on furlough, or lowering their wages as a way to share the pain.

Many of the lost jobs – in construction, finance, and outsourced manufacturing and services – are gone forever, and recent studies suggest that a quarter of US jobs can be fully outsourced over time to other countries. Thus, a growing proportion of the workforce – often below the radar screen of official statistics – is losing hope of finding gainful employment, while the unemployment rate (especially for poor, unskilled workers) will remain high for a much longer period of time than in previous recessions.

Consider also the credit markets. Prime borrowers with good credit scores and investment-grade firms are not experiencing a credit crunch at this point, as the former have access to mortgages and consumer credit while the latter have access to bond and equity markets.

But non-prime borrowers – about one-third of US households – do not have much access to mortgages and credit cards. They live from paycheck to paycheck – often a shrinking paycheck, owing to the decline in hourly wages and hours worked. And the credit crunch for non-investment-grade firms and smaller firms, which rely mostly on access to bank loans rather than capital markets, is still severe.

Or consider bankruptcies and defaults by households and firms. Larger firms – even those with large debt problems – can refinance their excessive liabilities in court or out of court; but an unprecedented number of small businesses are going bankrupt. The same holds for households, with millions of weaker and poorer borrowers defaulting on mortgages, credit cards, auto loans, student loans, and other forms of consumer credit.

Consider also what is happening to private consumption and retail sales. Recent monthly figures suggest a pick-up in retail sales. But, because the official statistics capture mostly sales by larger retailers and exclude the fall in sales by hundreds of thousands of smaller stores and businesses that have failed, consumption looks better than it really is.

And, while higher-income and wealthier households have a buffer of savings to smooth consumption and avoid having to increase savings, most lower-income households must save more, as banks and other lenders cut back on home-equity loans and lower limits on credit cards. As a result, the household savings rate has risen from zero to 4% of disposable income. But it must rise further, to 8%, in order to reduce the high leverage of household sector.

To be sure, the US government is increasing its budget deficits to put a floor under demand. But most state and local governments that have experienced a collapse in tax revenues must sharply retrench spending by firing policemen, teachers, and firefighters while also cutting welfare benefits and social services for the poor. Many state and local governments in poorer regions of the country are at risk of bankruptcy unless the federal government undertakes a massive bailout of their finances.

Moreover, income and wealth inequality is rising again: poorer households are at greater risk of unemployment, falling wages, or reductions in hours worked, all leading to lower labor income, whereas on Wall Street outrageous bonuses have returned with a vengeance. With the stock market rising while home prices are still falling, the wealthy are becoming richer, while the middle class and the poor – whose main wealth is a home rather than equities – are becoming poorer and being saddled with an unsustainable debt burden.

So, while the US may technically be close to the end of a severe recession, most of America is facing a near-depression. Little wonder, then, that few Americans believe that what walks like a duck and quacks like a duck is actually the phoenix of recovery.