Reply #77: Economy Falling Years Behind Full Speed

[Demeter]

http://www.nytimes.com/2009/04/07/business/economy/07capacity.html?_r=1&ref=business

By LOUIS UCHITELLE

As the recession grinds on, more and more of the nation’s means of production — its workers, its factories, its retail outlets, its freight lines, its bank lending, even its new inventions — are being mothballed.

This idled capacity, like baseball players after a winter off, takes time to bring back into robust use. So even if the recession miraculously ended tomorrow, economists estimate that at least three years would pass before full employment returned and output rose enough for the economy to operate at full throttle.

While stock market investors have embraced tentative signs of improvement in the mortgage market and elsewhere, even a sharp pickup in demand for products and services will take considerable time to play out.

The mathematics are daunting. The shortfall is running at more than $1 trillion in annual sales and other transactions. Only once since the Great Depression has there been such a severe loss of output — in the 1981-82 recession — and after that downturn, it was seven years before the economy regained the lost production.

Recovery from the current recession could be similarly sluggish. New occupants have to be found for empty stores. Factory owners who are hesitant to ramp up production will wait until they are sure of demand. Hiring the right people for an operation will take time. And imports, entering the country in ever greater quantities, will slow any expansion by siphoning sales from domestic producers.

Then there is the growth rate itself. In the six years of recovery from the 2001 recession to the current one, the economy grew at an average annual rate of only 2.5 percent, adjusted for inflation. If that growth rate were to resume, just $350 billion a year would be added back, requiring three years to restore the $1 trillion in lost capacity. But getting the economy to grow at all after so much output has been lost, and so many jobs, is no easy task.

“Excess capacity, once entrenched, perpetuates itself, and that is what is happening now,” said James Crotty, an economist at the University of Massachusetts, Amherst. “Companies cannot hire workers to make more goods and provide more services until their sales go up. But people can’t buy goods and services until they are hired — so the excess capacity just sits there.”

It shows up everywhere. Lawyers are booking fewer hours. Retail space goes begging. Tourism is down. So is cellphone use, airline bookings, freight traffic and household borrowing, which is less than half what it was on the eve of the recession, the Federal Reserve reports.

With orders dwindling, manufacturers are using less than 68 percent of the nation’s factory capacity, the lowest level since records were first kept in 1948. And while entrepreneurs are as inventive as ever, they may not be able to get venture capitalists to bankroll their creations.

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If there is an upside, it is the absence of inflationary pressure. With so much excess capacity rattling around, shortages do not develop that would push up prices. Indeed, interest rates are kept low to encourage more borrowing and spending. Neither is happening. Instead, demand continues to shrink and idle capacity to build up.

The Obama administration, like the Roosevelt administration 75 years ago, is trying to break this logjam through government spending, using it in effect as a substitute for consumers who are jobless or short of credit. The spending is also a substitute for companies that hesitate to extend themselves or see no profit in doing so.

But the president’s solution, the recently enacted stimulus package, spreads $787 billion over two years. So even if every dollar of spending restored a dollar of output, President Obama would be nearing the end of his first term before output approached the level achieved just before the start of the recession in December 2007.

Or so says Robert J. Gordon, an economist at Northwestern University who specializes in tracking the gap between actual output and potential output, a k a full capacity. The Roosevelt economy also languished well below full capacity, Mr. Gordon said, until the summer of 1940, when France fell to Hitler’s armies.

From then until the attack on Pearl Harbor, 18 months later, a galvanized administration more than doubled federal outlays — soon accounting for $1 of every $4 spent in the country — and the United States entered the war with its economy operating almost at full capacity.

(Government currently accounts for $1 of every $5 spent, barely more than in 2007, and most of that spending is at the state and local levels, the opposite of 1940-41, when federal outlays shot up.)

“What you had was a revolution in the labor force,” Mr. Gordon said. “Women poured into jobs in droves, often replacing men, and every factory went to three shifts.”

By V-J Day in 1945, the economy, propelled by war spending, was operating beyond what the experts thought of as full capacity, demonstrating the “squishiness” of the concept, as Mr. Gordon put it. Just the swing from one to three shifts alters capacity, he said, and so does the more intensive use of floor space.

Capacity stretched again in the 1950s and ’60s, to feed demand created by the wars in Korea and Vietnam, and then again in the late 1990s, propelled by the dot-com boom. And there were downdrafts as recessions sapped demand, but none as punishing as the current one.

Sixteen months into this recession, the economy is operating at 7 percent below its potential capacity, the Congressional Budget Office reported last month. If that were to continue, today’s $14 trillion economy would be a $13 trillion economy by this time next year.