New Year, New Economy?

There is a silly debate raging between the “September 11 changed everything” school and those who argue that the ghastly events of that morning changed almost nothing at all. Those in the first camp point to long airport security lines; the reluctance of Americans to open their mail in the carefree style of the days when anthrax was merely the name of a rock group; the conversion of Geraldo Rivera from a Clinton apologist on CNBC to a terrorist hunter on FoxNews; and President George W. Bush’s public embrace of Senate Majority Leader Tom Daschle.

The other side points out that New York held its mayoral election on schedule (though it may soon wish it hadn’t); the majority of Americans still commute to work just as they did on September 10; the World Series and the Super Bowl have come and gone; share prices are about where they would have been were the World Trade Center still towering over the financial district; and Daschle is in old-fashioned partisan form, reciprocating Bush’s hug with speeches about “the Bush recession.”

This squabble puts one in mind of the story of the rabbi whose enormous popularity so amazed his wife that she decided to secrete herself behind the curtains as he received people in his study. The rabbi told a wife who complained about her abusive husband, “You’re right, you’re right.” Shortly thereafter the husband visited and unleashed a diatribe against his wife, to be rewarded with a rabbinical “You’re right, you’re right.” When the rabbi’s wife later confronted him with the disgusted comment that he was merely seeking popularity because both of his visitors couldn’t be right, he replied, “You’re right, you’re right.”

So too with the all-has-changed, nothing-much-has-changed schools: they are both right. Anyone who has traveled by airplane recently knows not only that clearing security is now more difficult and tedious (whether this adds to security is another matter), but also that the new procedures are merely one symptom of Americans’ awareness that our country is no longer impregnable or immune to physical assault by determined enemies.

We know, too, that the nation’s perception of its president has changed. Even his supporters were less than certain of his foreign policy skills; his opponents were certain that those skills were somewhere between nil and negative. No longer: the patient and effective planning of a response to the terrorist attacks has persuaded the vast majority of Americans who are not tenured faculty members that President Bush knows how to pick his team, how to deploy its members, and how to resist both those who would have had him move precipitously and those who counseled Clinton-style inaction. Any doubts on the latter score were dispelled by the State of the Union address. Thus, those who see 2002 as a really, truly new year have some points on their side.

But so do their critics. The national mood may have changed, but day-to-day life for most folks goes on as before. Which seems to be what our government is urging, at least on some days. “Fly to Disneyland, hit the malls, go to the movies.” These suggestions from various officials certainly support the arguments of those who contend that nothing has changed since September 11.

Like the rabbi in the story, careful analysts know that both sides have some firm ground on which to stand.

Firmer Foundations

Start with what hasn’t changed. America remains the world’s only superpower, with the ability to project its military might to the far corners of the world. It also remains the world’s leading economy, more productive, richer, and more stable than any other in the world. Nothing that happened on September 11 has dampened its entrepreneurial spirit, or what my European friends see as our most important and endearing characteristic—the belief that in America anything is possible. The New York Stock Exchange was back in business four days after the financial district was reduced to chaos by the collapse of the twin towers; the financial services firm Cantor Fitzgerald, its staff decimated in the attack, is back in profit a very few months later; auto sales, stimulated by expensive promotions, hit near-record levels only weeks after the bombing; house sales slowed—for a week or so—and then resumed; our fidelity to the rule of law remains, despite temptations to sacrifice freedoms in defense of Freedom.

In short, the basic things that mattered on September 10—and the preceding list contains only a tiny number of those things (my social conservative friends would add that people continue to get married, raise families, and attend churches of their choosing)—still matter.

Interestingly, what has changed is that the basic underpinnings of American life are not only intact, but have become stronger: Patriotism is no longer a dirty word or an emotion attributed only to rednecks attending stock car races. Similarly, a society that prided itself on its lack of class distinctions has come face-to-face with the fact that firemen are indeed the equal of any of the high-flying investment bankers whom they sacrificed themselves to save, despite the differences in education, accent, and what has come to be called lifestyles. Family life has moved up several notches in Americans’ priorities: my business colleagues, until now unhesitatingly willing to fly hither and yon and keep in touch with their families by phone, fax, and email, now are more reluctant to distance themselves from hearth and home. It is not a fear of flying that is causing the drop in business travel, or even the slackening in the pace of mergers and acquisitions, but a desire not to be away from home if trouble strikes. This is merely one aspect of what Daniel Henninger, writing in the Wall Street Journal, called “the rediscovery of civic virtue.”

It is in the field of politics or, more properly, political economy, that we have difficulty distinguishing what has changed from what has not. We now live in a world in which conservative politicians want to stimulate the economy by a Keynesian-style tax cut that will throw the federal budget into deficit, and who vote overwhelmingly to expand the federal government by moving tens of thousands of airport screeners from the private sector onto the public payroll. Meanwhile, liberal politicians trip over themselves to show that they are as hawkish as the president and as willing as Defense Secretary Donald Rumsfeld (the new television heartthrob of the blue-rinse, seventy-plus set), to use our dominating military power to defend our nation, rather than rely on Clintonesque shop talks and “peace processes.” Whether that hawkishness will survive if Iraq proves to be the next target in the war on terror, or if growth in social programs must be pared to allow for increased defense spending, remains to be seen.

That is only one of the great imponderables at the beginning of a new year. It is difficult being an economist at this time of the year: for some reason, hope triumphs over experience, leading people to ask about the economic outlook. My response is either a weary shrug or a reminder that anyone who still believes in economists’ ability to forecast the near-term future of the American economy undoubtedly stayed up late on Christmas Eve in order to catch a glimpse of Santa Claus. The modernist Spanish sculptor Eduardo Chillida has described his art as a process of “Trying to get closer to what I don’t know.” Change don’t to can’t and you have the situation of those economists forced into the forecasting business.

Long after the present recession started, many economists continued to predict the further growth that 95 percent of forecasters had said was in America’s future—a consensus forged only one month before the recession began. An International Monetary Fund study of sixty recessions in developing and developed economies during the 1990s found that two-thirds were not foreseen by a consensus of forecasters as late as April of the year in which the slowdowns occurred.

Investment analysts possess even cloudier crystal balls. Remember, these are the folks who were urging us to buy Enron shares as recently as last October. Their 2002 forecasts for the Standard & Poor’s 500 Index range from 950 to 1570, meaning that share prices will either fall a bit or rise a lot. Not exactly a clear guide for the anxious investor.

But the inability to forecast does not make economists completely useless to business planners and readers of their scribblings. It is possible to lay out for the discerning reader the crosscurrents through which policymakers are attempting to navigate as the new year opens. I start with the bad news.

Potential for Collapse

The biggest threat to economic recovery remains former British prime minister Harold Macmillan’s greatest fear: “Events, dear boy, events.” If there is another effective terrorist attack, or a series of such attacks, it is not unreasonable to expect that consumers will eschew the malls and the airlines; investors will flee stock shares for less risky investments; foreigners will no longer see America as a safe haven and will drive the dollar down by unloading dollar assets; and that American businessmen, in turn, will be reluctant to commit to new projects.

Another event that would seriously impede the recovery that is showing signs of emerging from the downturn would be a substantial rise in oil prices. The OPEC cartel has announced a major cutback in production, and non-members Russia and Mexico (yes, the same Mexico that wants us to accept its policy of limited oil exports and unlimited labour exports) have agreed to go along, as has Norway. If there is no significant cheating on quotas, OPEC members and their fellow travelers will withdraw two million barrels per day from world markets. That might push prices up enough to impose the equivalent of a $100 billion-plus tax on American consumers, whose willingness to spend, spend, spend—even at the cost of running their debt up by $100 billion, or 20 percent—prevented an economic collapse in 2001. Of course, Russia’s agreement to cut back production by 150,000 barrels per day comes at a time when winter weather forces such a cut in output anyway, and may disappear with the melting of the winter frost.

American consumers prevented a serious collapse last year by snapping up cars, houses, and whatever Wal-Mart put on its shelves. And consumer confidence remains high. But when 2001 opened, the unemployment rate was a low 4.2 percent; it is now 5.6 percent. Employers, unable to raise prices, are finding more efficient ways to run their plants and offices. Continued productivity gains mean that joblessness will grow even as output recovers (although labor-force dropouts may push the unemployment rate down). Those job losses are widely trumpeted on television and in the press. If they unnerve consumers, it will be a while before the economy steadies.

In short, the bad news is that the stimulating effect of low oil prices is no more, there is not much room for further cuts in interest rates, and consumers might decide that the job market is so shaky that they had best rein in their spending. Add to that the inability of the president and the Democrats to agree on an economic stimulus package, and you have all the ingredients for a double dip, with the current revival becoming a famous “dead cat bounce.”

Forces for Recovery

Fortunately, many economists say that the worst is over and that the only questions are whether the recovery is already under way, or will start in the second or third quarters, whether it will be sharp or slow, and whether any recovery will survive a profits picture that many say cannot sustain even the current level of stock prices much less support a major bull run, especially in light of post-Enron suspicions about the realism of reported profits.

For those who believe that history has its rhythms, the cheer comes from the fact that since World War II, downturns have lasted between six and eighteen months, with an average duration of eleven months. So these econo-historians are confident that the recovery will be underway no later than the second quarter of this year.

More substantively, the full effect of the Federal Reserve’s rate cuts should be felt very soon, if indeed they are not already having an effect on durable goods and housing sales. These reductions, which have brought short-term rates to below 2 percent for the first time in forty years, have totaled 450 basis points, compared with cuts averaging only 180 basis points in the past six recessions, according to Business Week. There is no reason to believe that the interest rate reductions, reflected as they are in mortgage rates, will not provide a continued stimulus to the housing sector and to those areas related to it—home furnishings, appliances, and the like. Also, they should allow automakers to continue to offer generous rebates and financing.

Although the reductions in short-term rates have not been reflected in longer-term rates, there is some reason to hope that business will share the burden of carrying the economy forward. The inventory overhang is being worked off at a rapid rate—to the tune of $120 billion in the fourth quarter of 2001. International Strategy and Investment consultants (ISI), in a report to clients, points out, “The last time inventories were cut this much was during the 1982 recession which was followed by four quarters of almost 8 percent real GDP growth. . . .”

Add to the working off of inventories a drop in the massive excess capacity in the tech sector, a rise in the length of the average work week and personal incomes, the continued strength of the dollar, the revived receptivity of investors to initial public offerings of shares, the recent rise in corporate cash flow, and looser fiscal policy, and you have a picture that suggests the possibility of more than a modest recovery in business investment.

To say that not all of this is certain is to understate the case. But we can be more certain about the long term than about the near term. We know that a nation’s wealth and long-term economic performance does not depend not on the bounty of nature; witness the widespread poverty in many resource-rich nations of Africa and the Middle East, and the turmoil in Argentina compared with the economic achievements of Hong Kong and Singapore, neither of which has been blessed with natural resources.

Rather, enduring prosperity requires the presence of institutions that protect property, including intellectual property; a preference for open markets rather than protection; fiscal policies that permit the construction of adequate infrastructure while still leaving the bulk of the nation’s wealth in the hands of the private sector; and an entrepreneurial and risk-taking culture buttressed by a tax structure that rewards daring and hard work and institutions that guarantee fair dealing.

For that reason, one can be confident in predicting the long-run prosperity of America, whatever happens in the next quarter, or the quarter after that. Which is about as cheerful as a practitioner of the dismal science can ever get.