Tight purse strings choking the US recovery

The US economy needs more fiscal stimulus to get it out of its malaise. Unfortunately, profligate spending in the boom years means austerity is the order of the day and the recovery is still on hold.

The next big test for US markets will be tomorrow night’s non-farm payrolls data and the unemployment rate.

Even though the US economic recovery started over three years ago, the rate of job creation has been tepid, reflecting the unconvincing nature of the recovery and the damage that the worst recession since the 1930s Great Depression inflicted on the US.

The current consensus view is that employment will rise by around 120,000 in September, and the unemployment rate will edge up to 8.2 per cent, continuing the barely adequate recovery in the jobs market. Employment needs to rise by around 150,000 per month, on average, for the unemployment rate to fall in a sustained manner.

One of the curious aspects of the trends in employment since the pick-up started three years ago is the sharp fall in public sector jobs. Fiscal policy cuts at the federal and state and local government level has seen public sector employment drop 4 per cent since early 2009 – a move which has added around 1 percentage point to the national unemployment rate. That 4 per cent fall in public sector employment is a loss of around 1 million jobs. If ever there was a clear example of fiscal austerity shooting the economy in the foot, this is it.

Over that time, private sector job creation in the US has actually been respectable, rising by 4 per cent or around 4.5 million jobs (there are slightly different timelines for the peak in public employment and the trough in private sector jobs).

Many economists, including Nobel Prize winner Paul Krugman, have argued, quite rightly, that the pitch of the fiscal austerity is misguided. Fiscal policy needs to be counter-cyclical, meaning that when economic times are good, with strong growth and rapid private sector job creation, it is sensible for the government to cut spending and make room for that expansion. When economic conditions are more moderate, like now, it is prudent – indeed socially decent – to run deficits and have public sector demand adding to employment and economic activity.

It is simple.

The main problem in the US right now is that because fiscal policy was so poorly managed in the period from about 2002 to 2007 stimulus measures now are largely out of bounds. The US government in that 2002 to 2007 period operated massively pro-cyclical fiscal policy. This was a disaster. It gave tax cuts it couldn’t afford, spent money that was exclusively borrowed even though the private sector expansion and job creation were strong. This episode gave fiscal policy a bad name in terms of its ability to be used as a counter-cyclical policy tool.

Which brings us back to the US jobs data tomorrow.

If the consensus forecast is correct, the September labour force data will bring the tally to 41 straight months that the US unemployment rate has been above 8 per cent. The last time the unemployment rate was so high for so long was 1948. There will also be information in the economic release on hours worked, the participation rate and wages, which have been painting an even bleaker picture of the labour market than the unemployment rate would suggest.

The participation rate has dropped over 4 per cent since the economic crisis started – there are now around 5 million people who are neither employed, nor unemployed. They have dropped out. The hours worked series is also floundering near historical lows, suggesting overtime cut-backs and a move towards part time rather than full time jobs. Rounding out the dismal news is the fact that annual wages growth is under 2 per cent, one of the weakest rates of increase on record and yet a further sign that there is a huge amount of slack in the labour market.

It is little surprise, with this background, that the economy is the key aspect of the presidential election campaign. Many people have lost their jobs and have little prospect of getting them back any time soon. Those with jobs are working fewer hours, taking home pay cheques that are not keeping up with the inflation rate.

In these circumstances, it is easy to see the voter cynicism about extending tax cuts to high income earners or to decisions to cut spending and public sector jobs.

All of which comes back to the very basic point of hoping for a government that is good with money – having the backbone to be tight with spending and collect sufficient tax when economic times are good, but having the foresight to spend a bit more or tax a bit less when times are tough.

The US had done very poorly on that score for more than a decade. It is to be hoped that for whoever wins next month’s election, prudent and flexible fiscal policy is a priority.


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