Give the White House credit. Amid signs
that the recession is ending, administration officials
are resisting what must be an enormous
temptation to gloat. “I think we’re certainly on
track to, at least, stabilizing the patient,” said
Labor Secretary Hilda Solis during a recent cnbc appearance.
But “[t]he patient is still sick.” It’s hardly a triumphalist metaphor.
To the extent that there’s a problem, it’s not what the administration
is saying so much as what it is assuming: that the business
cycle exerts an irresistible gravitational pull—that what
goes down must eventually come up. “[B]ecause of the Recovery
Act, other rescue measures we have taken, and the economy’s
natural resilience, most forecasters
are now predicting that GDP growth
is likely to turn positive by the end of
the year,” Christina Romer, head of
Obama’s Council of Economic Advisers,
said in an early August speech
(emphasis added). Romer went on to
stress that 70 percent of the stimulus
will be spent by next October—
implying that growth should be
largely self-sustaining beyond that.
We wish we could be confident
of this. Unfortunately, even
granting that the worst is over,
it’s hard to believe that the economy
will be poised for steady
growth just a year or two after the
worst recession since the 1930s.
Pretty much everything we
know about the recessions that
follow financial crises suggests that
they last for an exceptionally long
time because they have to contend
with vast oceans of debt. During
boom times, people save less and borrow
more, leading to a surge of consumer spending. But, once
the crisis hits, overextended households abruptly retrench.
Saving shoots up as people pay down their debts; consumption
plummets and can languish for years.
Traditionally, there have been two ways out of such a recession.
The less painful one is through exports: Foreign consumers
offset the shortfall in domestic demand, raising employment
and income. But exports are unlikely to save us this
time around. The global nature of the recession means no advanced
economy is flush enough to serve as a buyer of last resort
(though some are now staggering into recoveries of their own).
Absent salvation through exports, the most plausible way to
crawl out of a recession caused by a financial crisis is for households
to pay off debt until they can afford to spend again. Indeed,
as Paul Krugman argued in a recent lecture series at the London
School of Economics (LSE), the reason that the United States
didn’t slip back into depression after World War II—something
many economists feared at the time—is that, 15 years after the
initial crash, people had finally put their finances in order.
Unfortunately, as the Depression example suggests, bringing
a nation’s worth of households back into the black can
take an agonizingly long time. According to data from the
Federal Reserve, household debt peaked at 128 percent of disposable
income in 2007. A recent San Francisco Fed paper
notes that it took Japanese companies, which had a similar
level of indebtedness when that country’s real-estate bubble
popped in the early 1990s, about a decade to push the ratio
down to a still-high 95 percent.
Alas, the practical and moral
consequences of a lost American
decade are too grim to contemplate.
The only solution may be an
approach that has long been anathema
in Washington: industrial
policy (that is, an active government
role in the development of
certain industries). In his LSE lectures,
Krugman quipped that “if
someone could invent the twentyfirst
century moral equivalent of
the railroad, or actually even the
moral equivalent of IT in the nineties,
that would help a lot.” We
agree: Innovations like the railroad
and the Internet tend to unleash
periods of rapid growth.
But waiting around for serendipity
to strike seems risky in
a moment like this. If, on the
other hand, the government
were to place some massive bets
on R&D, we might substantially
increase our chances of stumbling onto a major technological
breakthrough—or at least accelerate the process.
True, industrial policy is a lousy idea under normal circumstances:
Any invention with lucrative commercial applications
should have a high enough expected return to attract private
capital. Using government money to fund progressively longer
shots is likely to be wasteful. But, in a deep recession like this
one, the case for industrial policy gets much stronger. At worst,
the additional government spending would inject some needed
stimulus into the economy. At best, it might yield a technological
breakthrough that could attract a subsequent wave of
investment and make growth self-sustaining.