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How to avoid our own lost decade
By Lawrence Summers
Published: June 12 2011 21:59 | Last updated: June 12 2011 21:59
Even with the 2008-2009 policy effort that successfully prevented financial collapse, the US is now halfway to a
lost economic decade. In the past five years, our economy’s growth rate averaged less than one per cent a
year, similar to Japan when its bubble burst. At the same time, the fraction of the population working has
fallen from 63.1 per cent to 58.4 per cent, reducing the number of those in jobs by more than 10m. Reports
suggest growth is slowing.
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Beyond the lack of jobs and incomes, an economy producing below its potential for a prolonged interval
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FT.com / Comment / Opinion - How to avoid our own lost decade
sacrifices its future. To an extent once unimaginable, new college graduates are moving back in with their
parents. Strapped school districts across the country are cutting out advanced courses in maths and science.
Reduced income and tax collections are the most critical cause of unacceptable budget deficits now and in the
future.
You cannot prescribe for a malady unless you diagnose it accurately and understand its causes. That the
problem in a period of high unemployment, as now, is a lack of business demand for employees not any lack of
desire to work is all but self-evident, as shown by three points: the propensity of workers to quit jobs and the
level of job openings are at near-record low; rises in non-employment have taken place among all demographic
groups; rising rates of profit and falling rates of wage growth suggest employers, not workers, have the power
in almost every market.
EDITOR’S CHOICE
Lex: US corporate margins - Jun-09
US Treasury punishes banks for mortgage errors - Jun-09
Beige Book confirms break in supply chain - Jun-09
Return of optimism for US housing - Jun-08
Consumer credit increase for seventh month - Jun-07
Obama looks at extra stimulus - Jun-07
A sick economy constrained by demand works very differently from a normal one. Measures that usually
promote growth and job creation can have little effect, or 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, hence fewer jobs. Training programmes or measures to increase work
incentives for those with high and low incomes may affect who gets the jobs, but in a demand-constrained
economy will not affect the total number of jobs. 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.
Traditionally, the US economy has recovered robustly from recession as demand has been quickly renewed.
Within a couple of years after the only two deep recessions of the post first world war period, the economy
grew in the range of 6 per cent or more – that seems inconceivable today. Why?
Inflation dynamics defined the traditional postwar US business cycle. Recoveries continued and sometimes
even accelerated until they were murdered by the Federal Reserve with inflation control as the motive. After
inflation slowed, rapid recovery propelled by dramatic reductions in interest rates and a backlog of deferred
investment, was almost inevitable.
Our current situation is very different. With more prudent monetary policies, expansions are no longer cut short
by rising inflation and the Fed hitting the brakes. All three expansions since Paul Volcker as Fed chairman
brought inflation back under control in the 1980s have run long. They end after a period of overconfidence
drives the prices of capital assets too high and the apparent increases in wealth give rise to excessive
borrowing, lending and spending.
After bubbles burst there is no pent-up desire to invest. Instead there is a glut of capital caused by overinvestment during the period of confidence – vacant houses, malls without tenants and factories without
customers. At the same time consumers discover they have less wealth than they expected, less collateral to
borrow against and are under more pressure than they expected from their creditors.
Pressure on private spending is enhanced by structural changes. Take the publishing industry. As local
bookstores have given way to megastores, megastores have given way to internet retailers, and internet
retailers have given way to e-books, two things have happened. The economy’s productive potential has
increased and its ability to generate demand has been compromised as resources have been transferred from
middle-class retail and wholesale workers with a high propensity to spend up the scale to those with a much
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FT.com / Comment / Opinion - How to avoid our own lost decade
lower propensity to spend.
What, then, is to be done? This is no time for fatalism or for traditional political agendas. The central irony of
financial crisis is that while it is caused by too much confidence, borrowing and lending, and spending, it is only
resolved by increases in confidence, borrowing and lending, and spending. Unless and until this is done other
policies, no matter how apparently appealing or effective in normal times, will be futile at best.
The fiscal debate must accept that the greatest threat to our creditworthiness is a sustained period of slow
growth. Discussions about medium-term austerity need to be coupled with a focus on near-term growth.
Without the payroll tax cuts and unemployment insurance negotiated last autumn we might now be looking at
the possibility of a double dip. Substantial withdrawal of fiscal stimulus at the end of 2011 would be premature.
Stimulus should be continued and indeed expanded by providing the payroll tax cut to employers as well as
employees. Raising the share of payroll from 2 per cent to 3 per cent is desirable, too. These measures raise
the prospect of sizeable improvement in economic performance over the next few years.
At the same time we should recognise that it is a false economy to defer infrastructure maintenance and
replacement, and take advantage of a moment when 10-year interest rates are below 3 per cent and
construction unemployment approaches 20 per cent to expand infrastructure investment.
It is far too soon for financial policy to shift towards preventing future bubbles and possible inflation, and away
from assuring adequate demand. The underlying rate of inflation is still trending downwards and the problems
of insufficient borrowing and investing exceed any problems of overconfidence. The Dodd-Frank legislation is
a broadly appropriate response to the challenge of preventing any recurrence of the events of 2008. It needs to
be vigorously implemented. But under-, not overconfidence is the problem, and needs to be the focus of policy.
Policy in other dimensions should be informed by the shortage of demand that is a defining characteristic of our
economy. The Obama administration is doing important work in promoting export growth by modernising export
controls, promoting US products abroad and reaching and enforcing trade agreements. Much more could be
done through changes in visa policy to promote exports of tourism as well as education and health services.
Recent presidential directives regarding relaxation of inappropriate regulatory burdens should also be
rigorously implemented.
Perhaps the US’ most fundamental strength is its resilience. We averted depression in 2008/09 by acting
decisively. Now we can avert a lost decade by recognising economic reality.
The writer is Charles W. Eliot University Professor at Harvard and former US Treasury Secretary. He is an FT
contributing editor
Copyright The Financial Times Limited 2011. You may share using our article tools. Please don't cut articles from FT.com
and redistribute by email or post to the web.
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1.
Report bgeo | June 17 3:11am | Permalink
Timothy Geithner has the credentials of a learned and sophisticated economist.
"The lost decade" was a phrase used broadly to describe a commercial real estate disaster that seized-up the
total economy of Japan in the late 1980's and 1990's. During the later portion of the period known as "Japan's
Lost Decade" Timothy Geithner Served in Tokyo as a Treasury Department economic attache to Japan. A few
years thereafter Geithner served as president of the Federal Reserve Bank of New York.
It seems odd to me that a person who should have been so familiar with the signs of a bubble, and who had
actually lived and worked as an economist, in a country that suffered the consequences of a real estate
bubble, could have been so insulated from recognizing the impending bursting of the U.S. real estate and
mortgage finance bubble. It's particularly odd when you consider that, as president of the New York Federal
Reserve, Geithner was "living in the belly of the beast" - so to speak.
2.
Report bob.budding | June 16 9:44pm | Permalink
"When the facts change, I change my mind. What do you do, sir?"
~ John Maynard Keynes
Bravo, Professor Summers!
3.
Report Jeffry Lyon | June 16 9:40pm | Permalink
I say, where are the comments that were here? i cannot see previous pages of them. Am I missing some
navigation control somewhere?
4.
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Report ibsteve2u | June 16 8:10pm | Permalink
Probably should cut taxes some more, deregulate some more, block more alternative-to-oil energy measures,
and give away more America jobs with yet more inequitable free trade pacts.
I mean increasing the nation's trade deficits and incentivizing the wealthy to treat the American worker/people/
consumer - and the nation - as a "cost" is what got us here, so increasing the pressure cannot help but help,
right? Adding gasoline to a fire must be a good thing...I hear it said so much.
Oh, and let the corporations bring their $2 trillion they have stashed offshore to America tax-free. I'm sure the
few hundred Americans who will split that money will each hire...oh, say 60,000...pool boys and girls apiece
once their pile gets high enough to dive off of.
5.
Report Ike Forman | June 16 5:29am | Permalink
Because Larry Suumers is a politician he is going to get a lot of negative comments. The FT is perfectly
entitled to delete comments which disparage him, indeed I wish the FT had a tougher policy. Comments like
that from "Not Convinced" below are pointless. But removing all the coments is wrong, frankly the comments at
the FT are often better than the Journalism. In these times we need radical observations, the same old
viewpoint isn't going to help us. Personally I look looking back at historical articles and seeing what people
were saying, it's helps to understand how it all went so terribly wrong. Comments never make it to the letters
page, nor do they have any effect on the journalism. The FT treatment of commentators is essentially corrupt.
6.
Report larry | June 15 4:45pm | Permalink
Dr. Summers is wrong when he writes: The fiscal debate must accept that the greatest threat to our
creditworthiness is a sustained period of slow growth.” The greatest threat is the ongoing depreciation of the
dollar. Anyone who is not living in a cave knows that the so-called inflation rate as calculated by the CPI is
bogus. History shows that no legal tender irredeemable paper-ticket-electronic money survives because there
always comes a time when the monetary authorities cannot resist the temptation to over issue. The Catholic
Church has a line for this, and the Catholic Church has this exactly right: “In the face of temptation, reason
succumbs.” Drs. Summers, Bernanke et al are assuming that there is an unlimited reservoir of confidence in
the dollar. The empirical evidence contradicts this. Creating money out of nothing, a.k.a. QEI, QUII, etc.
depreciates the purchasing power of money that exists and, more importantly, the purchasing power of money
that has been promised for future payment, e.g., pensions, annuities, rents, interest on bonds, etc. The threat
is that the intricate web of mutual promises that hold society together could be broken, thereby destroying the
middle class. As the British are fond of saying, it’s the middle class that protects us from the barbarians. The
result could be Bolshevism. People who favor fiat money should take note. (for more information, see www.
thegoldshow.tv)
7.
Report David Klemitz | June 15 1:00pm | Permalink
Re removal of comments- it's 1984 I'm afraid (Ministry of Truth)
The Warning
"We didn't truly know the dangers of the market, because it was a dark market," says Brooksley Born, the head
of an obscure federal regulatory agency -- the Commodity Futures Trading Commission [CFTC] -- who not only
warned of the potential for economic meltdown in the late 1990s, but also tried to convince the country's key
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FT.com / Comment / Opinion - How to avoid our own lost decade
economic powerbrokers to take actions that could have helped avert the crisis. "They (Summers, Rubin and
Greenspan) were totally opposed to it," Born says. "That puzzled me. What was it that was in this market that
had to be hidden?"
http://www.pbs.org...frontline/warning/
8.
Report Angus Cunningham | June 15 12:13am | Permalink
"The central irony of financial crisis is that while it is caused by too much confidence, borrowing and lending,
and spending, it is only resolved by increases in confidence, borrowing and lending, and spending. It follows
that the central objective of national economic policy until sustained recovery is firmly established must be
increasing confidence, borrowing and lending, and spending. Unless and until this is done other policies, no
matter how apparently appealing or effective in normal times, will be futile at best."
While that seems quite true, can we make this observation usefully more accurate? I believe we can. I believe
so because in my opinion it is useful to recognize that another word for overconfidence is bravado. And,
indeed, when I make that substitution the diagnosis rings even more true for me.
Was it not bravado that, for example, led the leaders of the US Treasury, Federal Reserve, and Security
Exchange Commission not only to reject giving credence to Brooksley Born’s concerns about the uncontrolled
growth of complex financial products but also substantially to ignore the recommendations of the committee of
financial leaders who executed resolution of the bankruptcy of Long Term Capital Management?
"We should recognize that it is a false economy to defer infrastructure maintenance and replacement and
instead take advantage of the moment when 10-year interest rates are below 3% and construction
unemployment approaches 20% to expand infrastructure investment.
It is far too soon for financial policy to shift towards preventing future bubbles and possible inflation and away
from assuring adequate demand. The underlying rate of inflation is still trending downward and the problems of
insufficient borrowing and investing exceed any problems of overconfidence. The Dodd-Frank legislation is a
broadly appropriate response to the hugely important challenge of preventing any recurrence of the events of
2008. It needs to be vigorously implemented. But under-not overconfidence is the problem of the moment and
needs to be the focus of policy."
Isn't that judgment ignoring of the lessons we can learn from the unfortunate reality that the price bubbles of
the US housing market were widely accompanied toward its end by indulgences of conflicts of interest by
which certain “players” in the CDO and related derivative markets made money telling different people
contradictory predictions of expected security prices? Those bubbles and related conflicts of interest not only
occurred in the US housing market. They also occurred in the Icelandic, British, Irish, and European
playground housing markets, and they continue to this day occurring in the markets for debt in those countries
as also in many commodities markets uninhibited by Dodd-Frank (and still less uninhibited by any international
agreements so far on financial reform). Moreover, we should not forget that the very people who have most
benefited from the Fed’s and the Bank of England's QE programs appear to have been the ones who have
continued to facilitate such bubbles and related conflicts of interest -- as is indicated by BIS figures published
by The Economist in April for the share of derivatives in Greek, Irish, and Portuguese outstanding debt (see
exhibit at http://www.authent...ro_Debt_110418.JPG)
In short, while I agree that the US economy is demand constrained, the urgent issue is to make sure that QE
and other stimulus funds are not misdirected by a financial industry disinclined to distinguish speculative plays
from desperately needed capital in what many people are beginning to call transformative economic activity.
While there is naturally much debate needed to qualify sensible transformations from pie-in-the-sky feel-good
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ones, if the QE and stimulus funds are mostly, from the point of view of the whole economy, squandered on
speculative plays, we will never get out of the doldrums in which so many advanced economies are becalmed.
Angus Cunningham
Principal, Authentix Coaches
Toronto, ON, Canada
9.
Report whatdoiknow | June 14 10:41pm | Permalink
In my view the veracity of the modern economic theory is being put to a severe test by the ongoing crisis.
When this crisis is eventually over it is possible that many of our present day economic notions may have to be
restated.
It goes to the credit of FT that it has made its columns open to the leading luminaries of economic profession
to reflect and opine on the current burning issues. FT is doubly praiseworthy in that it has also provided a
valuable space to the readers to react on the views of the experts. Many of the reader comments are hugely
insightful emanating as they do from a wide spectrum of academicians, professionals and business executives
which largely comprises the subscriber community of this esteemed newspaper. Together, the original post
and the comments lay threadbare the issue under discussion, enabling the readers to see it in all its hues and
nuances, in a word in a larger and truer composite form. May I dare say that in the process of this churning of
ideas the readers’ reactions become an integral element of the entire discourse?
So, I would request FT that if it lets the original post stay in its cyber space, for the sake of truth and whole
truth it should let stay the readers’ views on them too. Otherwise, I am afraid the FT risks becoming a vehicle
of an agenda, rather than a forum to see issues objectively.
10.
Report Not Convinced | June 14 9:12pm | Permalink
Shame on FT for publishing article from this discredited, intellectually dishonest fellow from Harvard. He has
done more HARM to American Society with his FAILED pseudo Keynesian ideas!
Does any remember this is the same GUY ( one of the trio - Greenspan/Robert Rubin)who prevented the
regulation of DERIVATIVES proposed by then CFTC chairperson - Ms. Brooksley Born. See FIRST WARNING
documentary from PBS -FrontLine!
I am simply DISGUSTED
11.
Report remarklj | June 14 8:52pm | Permalink
I don't see how any serious discussion of American economic prospects can ignore our economy's increasing
and accelerating capital intensity. The law of comparative advantage dictates that, in the tradable sector, the
labor-intensive work (aka jobs) will be done where labor is relatively cheap. Globalization has removed
distance as an equalizer of costs. The old jobs have gone overseas, and the new ones (in manufacturing,
anyway) will be located there, even if demand returns. At least until American robots are cheaper than Asian
humans.
When the smoke clears, we will have to trim labor participation rates. We ramped up starting in the 1970's, with
the rush of women into the workplace, and now we have too many workers per household - certainly more
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FT.com / Comment / Opinion - How to avoid our own lost decade
than we need to do what we really want to pay people to do. I don't know how we will sort that out, but not
wanting to sort it out has put too many people in denial about our having to sort it out. Facts are not only
stubborn, they are unsentimental and they have no agenda. They just sit there waiting for less pleasant
hypotheses to make things worse.
12.
Report Carl Southwell | June 14 8:13pm | Permalink
I commented on this opinion last night, and my opinion disappeared. Apparently, some opinions are more
equal than others.
13.
Report logicus | June 14 7:36pm | Permalink
The usual growth mantra from a high priest. Is less growth so bad? Why not capitalism with a human face?
Live below your means, enjoy life more, more time for family and interests, save rather than spend on gadgets,
less trickle up, less tax for the military-industrial complex, less to be vacuumed off credit cards and bank
accounts by service monopoly pillagers. Three generation households instead of another mcmansion. Let
others stay in the rat race to provide the slaves and cannon fodder if they want.
14.
Report Josh Friedlander | June 14 7:34pm | Permalink
The removal of comments is a disgrace. Several friends referred me to this article specifically because of the
comments. Here I am, a little late, and there are no comments. Are you journalists or flaks?
15.
Report andiausa | June 14 4:26pm | Permalink
All the previous comments dissapeared due to their strong criticism of the author of the article l. summers.
16.
Report NB | June 14 1:39pm | Permalink
Where did the earlier comments disappear, please FT? I can only see one for now even though there has
been a "lively" debate during the last few days in comments to this particular A-list post.
17.
Report plainspeak | June 14 11:27am | Permalink
‘The central irony of financial crisis is that while it is caused by too much confidence, borrowing and lending,
and spending, it is only resolved by increases in confidence, borrowing and lending, and spending. Unless and
until this is done other policies, no matter how apparently appealing or effective in normal times, will be futile at
best.’
If I infer correctly from above, the central irony is rather that economic growth is a continuum of alternating
booms and busts, each bigger than the preceding ones. Wow! Feels like a wild roller coaster ride. Cannot our
illustrious Economists and Central bankers, please engineer something smoother.
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FT.com / Comment / Opinion - How to avoid our own lost decade
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