This recession (and the subsequent slow recovery) is different. It is a transformative event. The economy that ultimately emerges from these difficult times will be fundamentally different from the economy that existed before the recession.
We have seen this before. It happened during the Great Depression, when the economy was transformed from largely a private enterprise to a partnership of government and the private sector, what is called a “mixed” economy.
It likely will happen again, because the current recession is a demand recession. Consumers do not have enough money to purchase all of the goods and services that we are capable of producing, and consumer spending is the engine of the economy, representing about two-thirds of economic activity.
There are only three ways consumers can have more money to spend. First, they can save less. The less they save the more they can spend. Indeed, this is what Americans have been doing for the last 30 years. By the mid-2000s the savings rate approached zero.
The second way that consumers can have money to spend is by borrowing it, and American households also have been doing that over the past thirty years. In the post World War II era, household debt rose from about 25% of GDP to almost 100%.
The third way that consumers can have more money to spend is by making more money. But most workers do not make much more money than they did 30 years ago after adjustment for inflation, and for the past decade growth in real wages for all but the top few percent has been flat or declining.
In summary, in the past decades demand was not generated by making more money, but by saving less and borrowing more.
The problem is that we can’t save much less and we can’t borrow much more. Consequently, the only way out of this recession is the third generator of demand – increases in real income – and that is a difficult and long-term process.
It is especially difficult because of two interconnected factors, globalization and income inequality. Globalization grows the economic pie, by increasing productivity and expanding markets. However, it hits hardest the working middle-class whose labor rates are curtailed in order to compete with lower paid workers overseas. Thus, while the economic pie expands, income inequality increases.
Ultimately, it reaches the point where the standard of living of those at the lower or middle levels of the economic spectrum stops increasing, even though the nation’s wealth may still be expanding. At that point, you begin to lose the nation’s middle class and you approach oligarchy.