A Bad Economy
It is understandable that many are looking at the years of 2000-2009 as being a particularly bad period for the American economy. Job creation was virtually nonexistent overall and many millions lost their job during the recession of 2007-2009. Compared to the strong job creation years of the 1990s, the recent decade looks even worse. Incomes stagnated for all but those in the upper 5%. Economic growth measured by real GDP was notably poor compared to other decades. What we see are patterns of explanation for this that emerge by looking at the data, but we also see what has been a relatively poor performance by the economy over the course of the last thirty years compared to the prior thirty years. What we also see is that underlying weaknesses in the economy have emerged over the course of this period that has increasingly taken hold, and only periodic bubbles in selected markets masked these trends. The technology and stock market bubble in the late 1990s at least did leave behind important new companies, communications infrastructure, and technology. The housing market bubble left in its wake little that can be considered to be positive. At the same time we have seen incomes stagnate and American workers feeling less confident in a globalized world that increasingly results in more competitive capital and labor markets.
Real Gross Domestic Product (GDP)
The data (the source is the Federal Reserve Bank of St. Louis) demonstrates the fact that the economy has generally performed worse since 1980 than it did during the prior thirty years. Real GDP grew at an average annual rate equal to 3.96% during the period of 1950-1979 versus an estimated 2.71% during the period of 1980-2009. This relatively weak result since 1980 occurred during a period when lower taxes and deregulation were argued to be the primary drivers of economic growth. It has at the same time been increasingly noted in the press that the percentage of GDP dedicated to forms of public investment was also much lower and educational attainment suffered greatly compared to other industrialized countries. This is true even as workers in the U.S. are facing an increasingly competitive world. For example, expenditures as a percentage of GDP on public infrastructure exceeded 3% from 1950 to 1970, but since 1980 it has been less than 2%. It is a fact that bottlenecks due to infrastructure limitations, whether they be at airports, on freeways, or at the ports, all decrease productivity. While this decline in public investment in the U.S. occurred, economies in Asia are rapidly modernizing.
Looking at data on a decade by decade basis further highlights the weaker results. The economy grew at an average annual rate of 4.17% during the 1950s, 4.44% in the 1960s, 3.26% during the 1970s, and then 3.05% in the 1980s, 3.19% in the 1990s, and in period of 2000-2009 the average rate of growth was an estimated 1.89%. This outcome for the last decade is very anemic. The period of the 1980s was also especially disappointing given the policy changes enacted. If we excluded the recession year of 1980 then the average rate of growth would be 3.42% for the period of 1981-1989. However, I have to note that as we would expect from a long period of very poor results from 1980-1982, the economy bounced back strongly in 1983 and 1984. This outcome would probably be anticipated regardless of fiscal policies. On balance then, the 1980s was also a disappointing decade.
Real Household Income
The graph above demonstrating trends in real household income (the source is U.S. Census Bureau) illustrates what many people clearly realize. We see that all groups to different degrees lost ground during the period of 2000-2008 (the results will be worse if data for 2009 was included), but we can also see that the distribution of income has changed significantly. Household incomes in the lowest 40% have not seen real gains in income over the course of the last forty years. Those in the third and fourth income groups, those at between the 40th and 80th percentiles (middle to upper middle class) saw their household incomes increase in the late 1980s and late 1990s, but as we can see the gains were marginal at best. What is clear is that the vast majority of the gains in household income since the middle of the 1980s were primarily confined to those in the top 5%. This significantly widened the distribution of income to levels not seen since the late 1920s before the Great Depression. In 1980 the top 5% earned approximately four time what those in the middle quintile earned, but by 2008 the ratio was nearly six to one. Over time, as the middle class saw its income growth stagnate, saving rates declined to nearly zero before the recession of 2007-2009 started, household debt increased significantly, and the stress associated with paying for necessities increased. As the stock market has performed exceptionally poorly during the later years analyzed here and the housing bubble burst (see below) wealth accumulated by the middle class has declined to exceptionally low levels given the future needs of this population as they approach retirement, and stagnate incomes indicate difficulty for future wealth accumulation.
The Stock Market
The real or inflation adjusted performance of the stock market as measured by the Standard and Poor’s 500 Index (the source is Yahoo! Finance) reflects important trends because the stock market indicates both the current and expected economic environment. The graph above demonstrates that while there were up and down years during the period of the 1950s and 1960s, the general direction was for real gains in the stock market, consistent with the relatively strong economic growth during this period. The 1970s were a period in which exceptionally high rates of inflation negatively impacted the stock market due to poor fiscal and monetary policies at the end of the 1960s and in the early years of the 1970s, and the oil crises that occurred. In fact the 1970s was a chaotic period economically, but the economy grew at a rate that was approximately equal to that of the 1980s and 1990s. What we see above then in the 1970s was the result of the impact of high rates of inflation and related uncertainty in the financial markets. Then starting in the early 1980s was a stronger stock market, but overall, adjusted for inflation, the market did not match its level of 1968 until 1991. What we also see after this was steady improvement until 1994, and then the stock market bubble occurred, and then a collapse. Another bubble associated with economic growth and financial speculation related to the housing market bubble led to another surge in stock market values until the financial crises of 2008. Indeed, the period of the 2000s was overall negative for investors. Given the details above related to the economy, it is not surprising that the stock has performed poorly in recent decades.
Contributing to the results described above was also efforts to deregulate the financial markets in the 1980s and 1990s, and then a series of subsequent financial crises since the late 1980s. The result is what has been called the “bubble” economies of the 1990s and 2000s. Overall, during the period of 1950-1979 the S&P 500 adjusted for inflation increased at an average rate equal to 3.92%. On the other hand, during the period of 1980 to 2009 the average real rate of return was 5.86%, but if you exclude the speculative bubble years of 1994-1999 when the return was 23.41%, then the return was only 2.35%. In other words, only the speculative stock market bubble years were a real net gain in those years versus the prior decades. As indicated above, the difference between the 1990s and 2000s is that the 1990s gave us significant investments in communications infrastructure and technology along with a series of important cutting edge companies, but the housing market bubble seems to have yielded little of value.
Home Prices
The Standard and Poor’s Case/Shiller price index clearly indicates trends that will not surprise anyone who owned, bought, or sold a home during the 2000s. Historically home prices have increased at a rate roughly equal to the inflation rate. As a result households tended to view the equity they owned in a home as a stable asset or source of wealth accumulation. Both low interest rates and free lending practices that were either supportable or not facilitated efforts to finance home purchases in the 2000s. The poor stock market (see the relevant section above) caused households and investors to seek alternate investment opportunities, and this also led to increases in investment in housing. Over time the speculative demand for housing increased beyond levels supported by economic fundamentals. Other factors were also at work, but poor regulatory practices, very loose monetary policies, and very poor corporate governance, and greed were the primary factors that led to the speculative bubble depicted above both nationally and in a bubble city like the Phoenix-area. If you bought a home in Phoenix prior to 2001 than you are now marginally ahead, but if you bought after this time than you are likely not. Those who own a home in some separate local markets in the Phoenix area faired better. The results nationally during this time horizon have faired better with the value of their homes. On the other hand, the diversion of funds from alternative investment opportunities to housing and related financial assets, and the subsequent financial crisis starting in 2008, has a terribly negative impact on the economy. In addition, seeing as massive of a decline in asset values as depicted above leads to long-term reductions in expectations and greatly weakens household consumption.
Interest Rates
Exiting the high inflation and interest rate environment of the 1970s and early 1980s, the data (the source is the Federal Reserve Bank of St. Louis) for key interest rates demonstrate a process of lower and lower rates. Low interest rates were the natural result of the lower inflation expectations that took hold due to effective monetary policies in the late 1970s to the late 1980s, the impact of globalization, and other structural adjustments in the economy. We see this in the pattern shown above for long-term interest rates like the 10-Year Treasury and Mortgage rates. On the other hand, there were two occasions when it can be argued that Federal Reserve policies were too loose. These periods followed the recessions of 1991 and 2001. This is illustrated in the top graph above in this section by the long period of time in which the Federal Funds rate was kept at relatively low levels. This policy decision was prompted by the slow recovery of the labor markets after the recession, but as we have seen above we were really in a long period of relatively weaker economic performance. Added to these low interest rates, and arguably much more important, was a very weak regulatory posture due to policies by politicians and the Federal Reserve. Cheap money combined with a weak regulatory stance does contribute to speculative bubbles like those described above. It is also not surprising that the combination of easy credit, low interest rates, and households constrained by meager income gains seeking to leverage what they do have will lead to an explosion of household debt.
Conclusion
The economy has changed greatly in recent decades. Globalization, the pervasive use of technology (especially communication technology), computing, and an increasing level of competition have all altered the economy positively and negatively depending on one’s point of view. On balance, we have seen a rapid advancement in technology that is positive. Increasing productivity and competition were important factors contributing to the lower inflation and interest rate environment. Globalization leads to great connectivity among economies, and in the long-run this should be positive. Yet, in many ways the U.S. economy has underperformed for the vast majority of the population. As I indicated above, economic growth in recent decades has lagged behind trends associated with the thirty years starting in 1950. Incomes have stagnated for most of the population, and income inequality has grown to levels not seen since the 1920s. The stock market and housing market created speculative bubbles facilitated in part by investors divorcing themselves from economic fundamentals and deregulation combined with very poor corporate governance. These problems all call for the identification of solutions. Economists will turn to the efforts that increase productivity and competitiveness when identifying solutions. These include increasing investment in education, research and development, and infrastructure. In addition, in order to facilitate efforts by the public to adapt to the changing economic environment, institutions and programs that promote geographic and employment mobility are important.