Time to face fiscal reality

Wake up! The economic conditions that got us out of previous recessions don't exist this time.

August 25, 2002|By Charles W. McMillion | Charles W. McMillion,SPECIAL TO THE SUN

Even more than most inherently upbeat Americans, Marylanders are reluctant to face the consequences of the collapse in the stock market bubble and a return to a far more challenging reality. Irrational exuberance was grand while it lasted. It created fantasies of easy riches, emphasized spending money over earning it, and seemed to assure that any unpleasantness would quickly work itself out.

But because of these illusions and careless practices they fostered, the current prosperity cannot be taken for granted.

Of course, economic recessions come and go. Last year's recession went almost unnoticed in Maryland with strong income growth and, until recent months, year-over-year job growth. The economy has slowed, and job loss has accelerated in recent months. But inflation has remained low and the state's unemployment, which was less than 4 percent early last year, has only briefly flirted with 5 percent, far better than in earlier recessions.

Only a few people are alarmed at current prospects; everyone should be.

The state and the nation are in the midst of only the second "jobless recovery," much like that of 1991-1992, or the double-dip recessions of 1980-1982. At issue now is the strength and sustainability of the current recovery.

The expansions that followed each of our last two recessions were powered by the accumulation of unimaginable piles of debt as we spent far more than we earned. This was well known in the 1980s, symbolized by the soaring federal budget deficits. Although it got little media attention, the explosion of debt continued in the 1990s; it was simply "privatized" as household debt soared to previously unimagined levels.

The explosion of household debt got little attention in the 1990s because the stock market bubble greatly inflated the paper value of household assets. Cheerleading analysts and the bipartisan leadership in Washington insisted that the fact that debt was skyrocketing as a share of household income was irrelevant because debt was declining slightly as a share of paper assets.

Now that the stock market has come back down to earth (although valuations are still high by historical standards), household debt is again at record levels by all measures. When adjusted to include the shift to vehicle lease payments - not reflected in "debt" figures - households are paying far more than ever before just to service their debt; this despite the lowest mortgage rates in 40 years.

And since the stock market bubble mania of the 1990s, households stopped saving. Whereas more than 11 percent of each paycheck (and other income, including benefits) was saved in retirement or other accounts in the 1982 recession, and more than 8 percent in 1991, consumers spent all but 2.3 percent of their income last year - including their employers' contributions to their retirement accounts.

With so little set aside for medical or job loss emergencies, much less for retirement, consumers have begun to save a little more. They may soon also make the wise choice to pay down some debt. But this suggests that the pace of consumer spending could slow, perhaps substantially in coming months with no other broad engine to drive growth.

There are only four broad elements of the economy - so-called gross domestic product: consumer spending, business investment, government spending, and global export and import trade.

Consumer spending is two-thirds of the economy and has been the main economic engine for the past two years. But it seems set for perhaps prolonged weakness; certainly not acceleration.

Business investment has been weak or declining for the past two years and will not increase much until strong consumer demand growth seems assured.

The federal government increased defense spending after Sept. 11 but, with federal budget deficits again soaring, further increases are likely to be met with cuts elsewhere. Maryland's state and local governments, as elsewhere, are now being forced to cut back sharply as capital gains and other tax revenues decline.

Finally, and most important, there is global trade. Despite the accounting-challenged hype, as a matter of statistical fact, global trade has been a large and rapidly worsening drag on the economy for years. Just since 1990, U.S. current account spending on imported goods and services has exceeded all earnings from exports by $2 trillion and now continues at roughly $1.2 billion per day.

Maryland has lost to imports most of its more highly productive and high-wage manufacturing jobs. But now Maryland's vital professional services jobs are also being displaced by imports. Key to import competition is now China, which has joined cutting-edge technology with an almost limitless supply of very low-wage but highly skilled labor.

As a result, almost all net new jobs are now created in less-productive, lower-wage consumer sectors that do not face foreign competition. Unimaginable just a few years ago, Maryland has far more jobs in health care than in manufacturing and will soon have more in eating and drinking places.

These are the new realities and the new challenges of the post-bubble economy. The longer they are ignored, the less pleasant they will be to address.

Charles W. McMillion, president and chief economist of MBG Information Services in Washington, is the former associate director of the Johns Hopkins University Institute for Policy Studies.

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