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The American Recovery IsLikely to Be Illusionary

J. Bradford DeLong

Professor of Economics, U.C. BerkeleyResearch Associate, NBER

delong@econ.berkeley.eduJuly 26, 2009

The United States of America just has or will soon see the bottom of thebusiness cycle, at least as far as the semi-official National Bureau ofEconomic Research counts such things. But even though a recovery hasjust begun or is about to begin, the recovery will not feel like one. Fromthe perspective of the people’s livelihood of the average Americanworker—and from the perspective of its impact on American politics—theeconomic downturn is more likely than not to drag on for quite a whileyet.

At the Bottom of the Business CycleThe financial crisis gathered force from the summer of 2007 through thesummer of 2008. It then exploded into macroeconomic catastrophe afterthe collapse of Lehman Brothers last fall. It did more damage to theAmerican economy than most forecasters had dared to imagine, even intheir worst fears. Last December, the conventional wisdom and consensusforecasts of economists was that in the year 2009 the official headlineunemployment rate in the United States as reported by the federal

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government’s Department of Labor and its Bureau of Labor Statisticswould average something like 7.8 percent. Yet as of this writing theaverage unemployment rate for 2009 seems more likely than not to beabove 9.3 percent or higher—at least 1.5 percentage points higher thanwas estimated only seven months ago. Year-2009 real GDP in Americaalso looks to be lower than predicted—likely, as of this writing, to come inat $11.40 trillion rather than at the $11.53 trillion forecast by the incomingObama administration only last December.

It is worth pausing to notice the relative size of those two magnitudes. Theunemployment rate will be 1.5 percentage points or more above itsforecast as of last December. Real GDP will be 1.2 percent below itsforecast back as of last December.

Back in the 1960s one of President Johnson's economic advisers,economist Arthur Okun from the Brookings Institution, set out a rule ofthumb that was then quickly named “Okun's Law.” Okun found that if theworkings of the industrial business cycle were causing real GDP in theUnited States to rise or fall by a bit over two percent, then you couldexpect that the American unemployment rate would fall or rise by onepercent. The magnitude of swings in unemployment was always roughly alittle bit less than half the proportional magnitude of the swings in realGDP.

This was thought to be the case for four reasons:

• First, American businesses had a tendency to “hoard labor” inbusiness cycle recessions—seeking to keep their useful workersaround and on the payroll even when there was temporarilynothing for them to do on the factory floor.

• Second, American businesses would cut back hours wheneverunemployment rose, reducing output more than proportionatelythan the number of workers because total hours worked will fall bymore than total numbers employed.

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• Third, plant and equipment in American factories would run lessefficiently when hours were artificially shortened.

• Fourth, some workers who lost their jobs did not show up in theunemployment statistics, because instead of reporting themselvesas unemployed they chose to retire or to drop out of the labor forcealtogether.

For all four of these reasons, the rise in the unemployment rate duringAmerica’s business cycle recessions used to be a fraction of the decline inreal GDP relative to trend. According to Okun's Law, the unexpected extra1.2 percent decline in real GDP in 2009 should have been accompanied bya 0.5 or 0.6 percentage-point rise in the unemployment rate. Instead, theAmerican economy looks likely to experience a 1.5 percentage point risein the unemployment rate. I confess this comes as a surprise to me, but itshould not. The evidence that Okun’s Law has been broken—especiallywith regard to the retention of workers in a downturn—has been mountingfor decades:

• In 1993—two full years after the National Bureau of EconomicResearch said that the 1990-1991 recession in America hadended—the unemployment rate was still higher, and theemployment-to-population ratio lower, than it had been at therecession’s trough.

• In 2005—four years after the end of the recession of 2001—theAmerican economy was still seeing this same kind of “joblessrecovery.” It was not until 55 months after the 2001 NBERrecession trough called an end to America’s post-dot-com-bubbledownturn that a greater share of Americans were working than hadbeen working when real GDP was at its lowest.

Now in 2009, the American economy is starting once again to show signsthat its economic recovery will be “jobless”: real GDP will grow, but theunemployment rate will increase, the employment-to-population ratio will

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fall, and real wages for average, for poor, and for above average but notrich workers will stagnate.

So get ready for another jobless recovery.

One question is, why the shift? What has become different in the Americneconomy over the past two decades?

Paul Krugman has a theory: “[Past] recessions . . . were very different. . . .Each of the slumps—1969-70, 1973-75, and the double-dip slump from1979 to 1982—were caused, basically, by high interest rates imposed bythe Fed to control inflation. In each case housing tanked, then bouncedback when interest rates were allowed to fall again. Since the mid 1980s,however . . . recessions haven't been deliberately engineered by the Fed,they just happen when credit bubbles or other things get out of hand. . . .[T]hey've proved hard to end . . . precisely because housing—which is themain thing that responds to monetary policy—has to rise above normallevels rather than recover from an interest-imposed slump.”

I would guess—but it is only a guess—there is a second set of factors atwork as well here in America. Manufacturing firms used to think that theirmost important asset was their skilled and experienced workers. Especiallywhen economic recovery began, firms did not then want to lose hold oftheir prime productive assets. Skilled workers were the franchise.

Now, by contrast, it looks as though American firms think that theirworkers are much more disposable—that their brands or their machines ortheir procedures and organizations are the key assets that they mustsafeguard. They do not need to keep hold of their current workers,however, to keep the firm productive.

American firms, however, still want to keep their workers happy ingeneral. The hypothesis is that firms believe that their remaining workerswill not be upset if they fire employees and speed-up the pace ofoperations near the bottom of a downturn. The firm will plead that thereductions in the labor force and the changes in work rules are forced upon

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it by economic necessity, and workers will accept that plea at the bottomof a recession but, not at other times. Hence the start of the recovery isAmerican business's last moment to slim down its labor force and becomemore efficient and thus more profitable in the coming business-cycleexpansion.

That, at least, is the theory and my guess.

At least Americ is likely to see an economic recovery. The prevailingforecast right now is for real GDP to contract at a rate of one percent peryear or less between the first and second quarters of 2009, followed bygrowth between the second and third quarters at an annual rate of twopercent or so. When the NBER Business Cycle Dating Committee getsaround to it, it is most likely to call the end of this recession for June 2009,with the second most likely call for April and a date sometime after June2009 as a less likely possibility.

Yes, that would mean the recession is over right now. One reason for thatis the much-maligned stimulus package, which probably boosted the realGDP annual growth rate by about one percentage point in the secondquarter of 2009, and will boost it by another two percentage pointsbetween now and the summer of 2010.

This matters because it means that American demand for imports is likelyto start growing again… now.

But it also matters politically. The political question “Did the DemocraticParty’s stimulus package work?" well be answered with a “yes” ifobservers focus on real GDP and on the NBER business cycle turning-point dates. Democratic-Party members of Congress seeking reelection in2010 will be able to point to real GDP growth and an official end to therecession in the second quarter of 2009.

However, that is probably not the most relevant political question to ask,and not how the issue is likely to be framed. Comparing the second quarterof this year to the first, work-hours in America have declined at a rate of

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six percent annually. Work-hours from the second to third quarter arelikely to decline at a rate of about three percent per year. These numbersimply that American productivity is now growing at five percent peryear—not because of investments in new technology, but rather insteadbecause businesses will continue to fire workers in the belief thatremaining workers will accept their plea of economic necessity. If thequestion in the 2010 and 2012 elections becomes “Did the DemocraticParty make it easier to find a job or get a raise?” the answer will probablybe no.

And this matters. A return to power of the Republican Party in spite of itsvery disappointing policy performance between 2000 and 2008 is not outof the question. And an attempt to escape political dilemmas by blamingforeigners—especially Asians and the manufactured goods theymake—for high American unemployment is not out of the question either.

July 26, 2009: 1668 words.