Economic Malaise?

With jobs not returning as quickly as expected, and economic statistics mixed, many people are wondering if we are in for a “double dip” recession, or if the first “dip” has really ended.   What’s going on.

The answer is surprisingly clear; I reflected on it as I bought my son a new bike.  It was $100 at Target — a nice mountain bike, 20 inches, 21 speeds — and I thought to myself, “well, at least I’m helping the economy.”    And, of course, it does give some help to Target’s workers and corporate profits.   The bike, however, was made in China.   Therein lies the problem.   If the economy is stimulated through things such as tax cuts or more consumer spending, it usually goes to buying goods produced in foreign countries.   That actually worsens the underlying problems of a current account deficit and debt.   No recovery can happen without an increase in production.

To free marketeers the answer seems easy — just let the market do it with fewer regulations and lower taxes.   Alas, that is not a viable solution, the market will not on its own stimulate production.   The reason is globalization — reduce taxes and regulation and capital is as likely to seek profit abroad as at home.   Moreover, given that lack of regulative oversight caused the derivatives market to boom, thereby causing the bubble economy’s crash to be so toxic, the idea that less regulation magically leads to economic growth is dubious.   It’s not the amount of regulation, but having effective regulation.   Moreover, more heavily regulated and taxed Europe (especially Germany) is weathering the recession much better, the idea that there is a magical solution of just sitting back and letting the market work is delusional.

Yet we can’t just spend our way out of it either.   The problem is that any growth we get tends to involve increasing the trade deficit, which only enhances the problem.  We have become a country where people try to buy and sell, but not produce.   People want to figure out a way to make easy money, sometimes working very hard, but we aren’t producing enough on our own to get the economy moving.

Part of the problem is the death of the middle class.   The middle class has been constantly shrinking so you either have the very rich, usually living on investment income, the professional elite, or the poor working in the service sector.   The backbone of the US economy had been a large, productive working class, able to purchase consumer goods and have a quality lifestyle.   Fewer people than ever fit that description.

It was tolerable until now because we’ve had the Chinese providing cheap goods, meaning that with Walmart and cheap textiles, toys, and electronics a declining income did not necessarily mean you couldn’t keep consuming.   In essence, we had the equivalent of Chinese slaves producing for us, helping put American factories out of business.  Credit was cheap too, so people sacrificed their savings and got comfortable carrying debt.

To many Americans this had an upside.   I don’t want my kids to have to work in a factory, and most Americans started to see routine labor as something to avoid, instead going to college to find a profession.   Factory workers didn’t want their children punching a time clock — it’s the American way to want something better for the next generation.   The mills are closing in Maine, but how many people want their kids to work in a mill?   The problem is that if we want to close factories, we still have to produce something else of value that people here and abroad want.   We can’t all be doctors, lawyers, managers and accountants.

To rebuild the economy we have to rebuild a productive working class.   We have to produce.   But what can we produce?   We can’t undercut Chinese prices; trying to make US products as cheap as third world products would not pay a middle class wage.   Protectionism isn’t an option — China would stop financing our debt and could even hurt us by dumping dollars, stocks and bonds.   And anyway, the Smoot-Hawley bill 80 years ago during the Great Depression shows the danger of protectionism.

The problem is that the structure of the economy is not one where there are free market incentives to build a stable productive middle class.   With cheap foreign goods and high debt, the market now has incentives to further bifurcation of the US economy until inevitable class warfare breaks out.    We already see it with the so-called “tea party” movement on the right.  While they eschew talk of “class,” much of it is driven by anger at the establishment, with economic populism rampant.

If we were a third world country this would be “solved” by the market through high inflation, forcing us to buy and produce our own goods because foreign goods would become too expensive.   The US economy is too big, and the dollar still too trusted for that to be likely.  Government spending to enhance production is one feasible solution.  Some of this is already working with General Motors, and efforts to jump start alternative energy production are positive moves.    Moreover, the information revolution and “new economy,” used so far mostly to enhance the buying and selling of “traditional” products, may give us paths to produce non-industrial products that nonetheless have value.   Small companies producing local goods and generating a loyal customer base might help.    But I’m at a loss as to how we can turn this around.  We’ve been digging this hole for thirty years, there’s no easy way out.

Lastly, tax reform is necessary.   Right now taxes squeeze the middle class the most, with large chunks of our bifurcated society too poor to pay taxes.    The very wealthy can easily find tax shelters and accounts/tax lawyers adept at avoiding the taxman.   Those rich enough to be in the higher tax brackets, yet not wealthy enough to finance legal tax evasion, pay the highest percentage of their wealth.   This further bites the shrinking middle class, and breeds resentment of the nearly 50% too poor to owe taxes.

Still, the fact remains:  we need to produce.  We cannot consume our way to economic well being.   Until we produce value, we cannot expect economic recovery.

UPDATE: Talking Points Memo has a great graph illustrating precisely what I mean.