Who Will Mop Up After the Economic Deluge?
The stock market disaster of Oct. 19 is still reverberating through the headlines like an earthquake with a Richter reading of 10. Analysts continue to sort amid the rubble to assess the damage. And we are all scratching our heads wondering about its implications for our economic future.
Ever the cheerleader, President Reagan insists that the economy itself is fundamentally sound. Ever seeking to shed their image as “dismal” scientists, flocks of professional economists have been issuing relatively upbeat economic health bulletins.
These are delusions, I think, and should be vigorously resisted. The U.S. economy is suffering from serious structural problems. It is quite likely that the stock market plunge over the past several weeks has represented a renewed concern about these underlying problems. And with stock market investors having finally pulled their heads from the clouds, it is equally likely that these problems will soon get worse.
The economy suffers two basic structural weaknesses that helped trigger Wall Street’s recent collapse.
The first flows from unyielding stagnation on the supply side of the economy, in the production and delivery of goods and services. The Administration frequently plays its broken record about the continuing “expansion” and record-setting employment levels. But the recent expansion has been sustained over the past two years by demand-side borrowing--as represented by both the persistent federal deficit and debt-financed consumer spending.
Behind that borrowing, the economy continues to sputter. We can compare the economy’s performance over the recent business cycle with the cycle that everyone loves to hate, the sluggish stagflationary cycle from 1973 to 1979. In the 1979-86 period, the rate of growth of real output was nearly a quarter slower than in the 1973-79 cycle. Much worse for future performance, productivity growth was just as limp as before. Further, the rate of growth of real net investment--that is, all non-residential investment in productive plant and equipment discounted for inflation--fell to less than 0.1% from 1979 to 1986 from an average annual rate of 1.1% in 1973-79.
Sluggish Performance
The second structural fault flows from the first. With such feeble supply-side performance, the economy has continued to expand because its weakness has been papered over with debt. We are now staggering under the weight of those aggregate IOUs. The federal deficit is not the only or even the most serious instance. I reported in this column earlier this year that the ratio of total private-sector debt to gross national product, a reasonable measure of the weight of relative corporate, household and farm debt obligations, had risen so rapidly over recent years that sometime in 1986 it surpassed the extraordinary levels it had reached in 1929, just before the Great Crash.
Sluggish supply-side performance. Staggering debt burdens. Most accounts of Wall Street link its oscillations to momentary blips like Treasury Secretary James A. Baker III’s outburst against the West Germans. But is it likely that these longer-term problems could have made Wall Street so skittish over the past several weeks?
I think so. Let’s look at each of the two structural problems. The economy’s weak supply-side performance is the principal cause, for example, of our declining international competitiveness. (As I also have argued in earlier columns, U.S. trade problems reflect lethargic productivity growth, not excessive wage growth.) Huge and persistent trade deficits have resulted. The dollar is going to continue falling until the deficits begin to attenuate.
Two Main Problems
But Wall Street knows that further erosion of the dollar’s value will begin to scare away the foreign capital that has been helping underwrite our debt.
And if that happens, through one channel or another, interest rates are likely to soar. Which would help trigger an overdue recession. Which would make everything worse.
Wall Street is equally aware of mountainous private and public debt.
It is in the nature of borrowing binges that they continue until sudden gusts topple the house of cards. The financial community has grown more and more concerned that the next most likely gust would come from a sharp recession--all the sharper because it has been delayed so long by debt-financed expansion.
And so Wall Street has grown increasingly jumpy at any little firecracker explosion that might signal the onset of contraction.
As interest rates began to creep upward in late summer, the crackle and pop grew louder and Wall Street grew edgier. Early October announcements of further interest-rate increases surely helped condition the mid-October stock market plunge.
And now, of course, Wall Street’s fears are becoming self-fulfilling. Concerns about recession have both contributed to the plummeting stock market and raised the likelihood of the recession.
I would argue, in short, that the stock market debacle in October reflected real problems and should not have seemed so surprising. The underlying structural problems had made it essentially inescapable. Some Wall Street realists, indeed, had seen through the bull market ebullience and recognized the underlying fragility.
Wall Street fixer Felix Rohatyn wrote in June, for example: “The relationships between exchange rates and trade, between interest rates and economic activities, between fiscal and monetary policies, have become less and less predictable. The potential for a major shock in the credit system and the securities markets gets greater and greater. . . . What appeared to be only a possibility five or six years ago became a probability more recently, and has now become a virtual certainty.”
Now that the “virtual certainty” has indeed occurred, at least in part, what can we do about it?
If two basic economic problems have contributed to the current financial fragility, then it follows that the fragility will probably continue or worsen until those two underlying problems have been substantially moderated.
On the first front, our supply-side problems require a fundamental shift in strategy. We have tried throughout the 1980s to practice trickle-down solutions through “profit-led” productivity growth, seeking to boost investment and productivity by fattening corporate coffers and the bank accounts of the wealthy. This strategy has failed.
We should turn, instead, toward what several of us have been calling “wage-led” productivity growth. We should move toward fuller employment, secure and stable real wage growth and more wage equality. This would contribute to a revived and more productive economy by providing a firmer (less debt-ridden) base for consumer demand, by pushing firms to make more productive use of their employees and by giving workers a stake in the success of the economy.
We need a comparable shift in our strategic approach to the debt problem. Just as federal officials are now negotiating over the federal deficit and just as many have already proposed “restructuring” Third World debt, we need to enter careful and sustained negotiations with the banks to begin restructuring private-sector debt.
Painful Reminders
We need to push banks to write off a certain percentage of corporate, household and farm debt in return for enhanced guarantees of government financial safeguards. And we need to tighten our political leverage over interest rates (through reduced political independence for the Federal Reserve Board) to protect against interest-rate fluctuations undermining the potential effectiveness of those kinds of negotiations.
We have received some painful reminders that our economy is not in the best of health. But perhaps we will finally stop fooling ourselves. “Our problem is not simply to put Wall Street in order,” Nobel laureate Wassily Leontief said last week, “Our problem is to put the economy in order.”
Perhaps we will now abandon our intemperate faith in voodoo economics and financial flappers. Perhaps we will now get down to work and begin the long, slow, difficult transition toward a more effective and a more equitable economy.
