December 2010 Big Grower

It’s Official, Now What? By Charlie Hall

The National Bureau of Economic Research (NBER) declared recently that the so-called great recession actually ended in June of 2009. The popular press has been largely panning this pronouncement, saying that it is out of touch with Main Street where the pain of the downturn is still being felt. But this is due to a fundamental misunderstanding of what the NBER is actually dating.

A recession occurs when there is a substantial broad-based reduction of economic activity, as measured by a number of economic indicators ranging from industrial production to employment to overall GDP. A recession is technically over when the contraction comes to an end, not when the economy gets back to pre-recession levels of economic performance.

For economists who regularly watch the numbers, it was pretty clear that this recession has been over for quite some time — the only question was the exact date the NBER might choose. The recovery has been a lot slower than policymakers or Main Street would like, however none of this is surprising. Most economists still expect below-average growth rates over the next two years as the Federal Reserve begins to unwind historically low interest rates and massive budget deficits. This means consumer spending will continue to grow at a slower than normal pace.

There is also likely to be continued weakness stemming from both the residential and commercial real estate markets as they continue to work through the backlog of excess houses and issues with bad debt. Employment growth will continue to be moderate, implying that it could be late 2013 before peak employment levels return and late 2014 before unemployment drops below 6 percent again. However, the short-term outlook isn’t all bad news. These weaknesses are being offset to some extent by growing exports and decent trends in business investment in equipment and software.

Unlucky Streak
One of the most challenging aspects of this latest downturn has been, of course, the sharp decline in consumer spending. One of the consistent mantras from policymakers has been that the economy can’t fully recover until consumer spending starts to grow again at a normal pace. Sure, official statistics say that the economy has been growing for nearly 15 months, but it has recuperated so sluggishly that most people seem to think it is still in recession. For a few months it looked as if the economy might even shrink again, as growth slowed to a mere 1.6 percent (at an annualized rate) in the second quarter, job creation almost stopped, and home sales plunged.

Admittedly, we had quite an unlucky streak during the second quarter as Europe’s debt crisis and the BP oil spill sapped business confidence and an anomalous surge in imports ate into growth. More recent indicators on jobs and trade have all but put to rest fears of an imminent return to recession and a burst of corporate mergers, including several bidding wars, suggests that business confidence is improving slightly. Nevertheless, in the third quarter the economy has probably been growing at a rate of only 1.5-2 percent, while a pace of 2-2.5 percent is likely in the fourth — all this being more like the proverbial turtle than the hare.

Since the recovery began, the economy has grown at a rate that is a little less than 3 percent. That is faster than its long-term potential (about 2.5 percent), but the United States has typically come out of deep recessions in the past at rates of 6-8 percent. So far, job creation has been too weak to lower unemployment significantly, which at 9.6 percent is much as it was at the start of the recovery. So what makes this recovery different?

Two widely held beliefs prevail among economists regarding recoveries — deep recessions usually lead to strong recoveries and financial crises usually produce weak recoveries. But the curious thing about the great recession is that it was a deep recession kick-started by a financial crisis and fostered by a sundry of asset bubble bursts. A growing body of research has found that such recoveries tend to be slower than those after “normal” recessions. Since 1970, in the first two years after normal recessions, growth has averaged 3.7 percent, but after abnormal recessions caused by financial (or other bubble-bursting) crises, growth averaged only 2.4 percent. Thus far, we have been doing only slightly better than this.

Down the Road
The Federal Reserve brought on most of the previous post-war recessions by raising interest rates to squeeze out inflation. When the Fed cut rates, demand revived. However, financial crises interfere with the transmission of lower interest rates to private borrowers. People either can’t or won’t borrow because the value of their collateral (e.g. their homes) has fallen. Banks have been less able to lend because their capital was depleted by bad loans or they were less willing to loan because customers can’t meet tighter underwriting standards.

Government spending has helped fill the hole with direct federal injections of cash and cuts in taxes. But this has been neutralized by state and local cuts and with the bulk of the stimulus now winding down and housing tax credits disappearing, we’re feeling some new pain. So if the economy is to grow much faster than its 2.5 percent trend, consumers must start borrowing and spending again. Many pundits say that with the new normal, this may be a while in coming.

While I agree with my colleagues for the most part, I do see a silver lining in the clouds (which shouldn’t be much of a surprise to those who regularly read this column). According to the latest BEA report on “Personal Income and Outlays,” real personal consumption expenditures (adjusted for inflation) reached a 27-month high of $9,321.2 billion in August, the highest level of consumer spending since May of 2008. Real consumer spending in August was just $34.3 billion, which is a mere 0.37 percent below the peak of $9,355.5 billion reached in December 2007, the month the U.S. economy went into recession.

During the 16-month period between January 2008 and April 2009, real personal consumption fell in 13 of those months; in the 16-month period from May 2009 to August 2010, consumer spending increased in 13 of those months as the economy gradually recovered. Over the last seven months, consumer spending has increased in every month except April. The August increase in real spending was the fourth straight monthly increase and beat the expectations of most economists.

So whether this trend will continue is the real question. Or is it just another case of lies, darn lies and statistics? Either way, green industry firms need to be looking strategically at their value propositions and implementing innovative ways to articulate them to their customers. n

Charlie Hall is Ellison Chair in International Floriculture in Texas A&M University’s department of horticulture. He can be reached at charliehall@tamu.edu.