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Beyond the Great Recession

By wmadministrator

There may be disagreement about whether the so-called Great Recession that started officially in December 2007 is finally over. What is not in dispute, however, is that our economy is still in dreadful shape and people are hurting. There may be some consolation in knowing that the economy will eventually recover from the current crisis. Unfortunately, the long-term prospects for the U.S. economy are quite alarming, unless far-reaching steps are taken soon.

The U.S. unemployment rate at 10 percent of the labor force is at the highest level since 1982. Since the start of the recession, the economy has lost 8.5 million jobs, and many of these jobs are gone permanently. The federal government’s budget deficit this year is estimated at $1.6 trillion. A large part of this is the result of declining tax revenues and a surge in government spending necessitated by the Great Recession. Then there are the tax cuts from the Bush years, and the unfunded wars in Iraq and Afghanistan; the Bush era tax cuts cost $1.8 trillion. Even after the economy recovers from the current crisis, large government budget deficits are expected to persist.

This brings us to the national debt, which represents the accumulation of past deficits. It stands at $12.4 trillion and is almost equal to the size of the economy itself. The national debt has more than doubled since 2000 when it stood at $6 trillion. The interest payment alone on the national debt was $383 billion in 2009; as a point of comparison, the federal government spent $54 billion on education in 2009. The national debt will come under even more stress thanks to the aging population and the upsurge in medical costs. If current trends continue, the national debt will explode after 2020.

Much of the national debt is owned – in the form of Treasury bills – by Americans, but an increasingly large share is owned by foreign investors. The U.S. trade deficit is about $700 billion a year and represent what we are borrowing from the rest of the world to bridge the gap between our spending and our earnings. This large trade deficit implies we essentially are living way beyond our means. By borrowing from foreign countries to finance our consumption, we are enjoying a living standard that is much higher than we can actually afford.

So what does the looming financial catastrophe mean for the U.S. economy? Well, lower rates of economic growth and sharp reductions in living standards, among other things. As excessive government borrowing pushes up interest rates, private spending will be crowded out, lowering productivity, economic growth and living standards. As more people become permanently unemployed, a vast underclass of unemployed workers is likely to emerge. To provide employment to these workers, the economy will have to create new jobs, which will not be easy. The skills required to take on these jobs may take a long time to acquire. As the gap between the poor and the wealthy widens, government finances will come under even more strain. To make matters worse, foreign investors may be less and less willing to lend their savings to the U.S. government, and that will push interest rates even higher, compounding our economic malaise further.

Does this nightmarish scenario mean doom? Well, not necessarily. However, it does mean that we need to make some very tough choices, and soon. The reality is that the government will need to cut spending and raise taxes. Every major program or issue must be addressed head on and needs to be on the table, including healthcare reform, Medicare and Social Security. But are our political leaders willing to make these difficult choices?

Sadly, the current political climate in Washington does not lend much reassurance. For instance, most politicians will tell you that they are very concerned about the escalating deficits and the ballooning debt, and the burden being placed on future generations. But what have they proposed to deal with the problem? Not a single one has articulated a reasonable or specific plan to raise taxes or reduce government spending in areas that will have any significant impact on the budget deficits.

Inadequate savings
The fundamental problem the U.S. economy faces is one that has afflicted it since the 1980s – inadequate savings. Total savings in the economy consists of government saving and private saving by done by households. The negative saving (deficit spending) of the government has already been alluded to. For their part, U.S. households save very little, if any, of their income. Given this lack of domestic saving, private firms have had to rely on savings from foreign sources to fund productive investments that are essential for economic growth and quality of life of future generations.

The solution, therefore, is to increase the levels of government and private saving. To achieve the former, a combination of tax increases and spending cuts will be necessary. To increase the latter, tax policies that increase incentives for individuals to save more of their income are essential. Comprehensive healthcare reform is absolutely necessary; although this reform will require sizeable outlays upfront, the cost of inaction will be many times greater in the long run.

The long-term prospects for the U.S. economy are not encouraging. And time is running out. But there is hope. The question is whether our political leaders will find the courage to do what is necessary and right.