The Failures of the Recovery from the Great Recession
Michael Meeropol and Jared Ragusett
When Barack Obama took over as President, there were fears that the United States was heading for a re-run of the Great Depression. The financial meltdown that became apparent during the 2008 calendar year had sparked a dramatic recession – which has come to be known with 20-20 hindsight as the Great Recession. When Obama took office, the economy was hemorrhaging 700,000 jobs a month. The unemployment rate had climbed to 9 percent and it was still going up. Something had to be done.
Obama’s program passed the House and Senate in March of 2009. It was just enough to stop the bleeding and begin what turned out to be a painfully slow recovery. But because of a combination of Democratic timidity and Republican opposition, the size of the macroeconomic stimulation contained in the Recovery Act was much too small. In order to get the 60 votes needed to defeat a Republican filibuster, the Obama Administration had to pare back their proposed spending increases and tax cuts in order to satisfy the deficit hawks among the Democratic majority. The result was an historically slow recovery which was the reason the House flipped to the Republicans in 2010 and the Senate flipped to the Republicans in 2014. It was also one of the reasons Donald Trump was elected President at the end of Obama’s two terms.
Real GDP growth was slow through 2016. Investment incentives had been severely damaged by the housing bubble during the years 1995-2005 followed by housing bubble meltdown during the years 2005-2009. During the Obama recovery housing investment barely budged reducing the overall level of investment. This led to a miniscule productivity growth rate. Meanwhile consumption spending which is the key incentive for the revival of investment during business cycle upswings rose slowly as well. It took a long time for the unemployment rate to fall to its pre-recession level.
Obama won re-election in 2012, but up and down the ballot (including in many state legislatures and the House of Representatives beginning in 2010), Republicans cashed in on the impatience of citizens with the slow pace of recovery. The economy did not get back to “normal” until 2016 but it was too late for the Democrats. Trump was able to ride to a (razor thin) victory in part on the strength of disappointment by many people who had voted for Obama, both rural whites in key states like Wisconsin and Michigan who switched to Trump, as well as Black voters whose turnout fell in Detroit, Philadelphia, Pittsburgh and Milwaukee. This had devastating electoral consequences for three crucial battleground states (Krogstad and Lopez, 2017).
Obama’s Challenge
When President Obama took office, all eyes were focused on the short run challenge of the Great Recession. Here’s how his Council of Economic Advisers stated it, a year later in the Economic Report of the President, 2010:
“In December 2007, the American economy entered what at first seemed likely to be a mild recession. … [R]eal house prices (that is, house prices adjusted for inflation) had risen to unprecedented levels, almost doubling between 1997 and 2006. The rapid run-up in prices was accompanied by a residential construction boom and the proliferation of complex mortgages and mortgage-related financial assets. The fall of national house prices starting in early 2007, and the associated declines in the values of mortgage-backed and other related assets, led to a slowdown in the growth of consumer spending, increases in mortgage defaults and home foreclosures, significant strains on financial institutions, and reduced credit availability. By early 2008, the economy was contracting. Employment fell by an average of 137,000 jobs per month over the first eight months of 2008. Real GDP rose only anemically from the third quarter of 2007 to the second quarter of 2008.
Then in September 2008, the character of the downturn worsened dramatically. The collapse of Lehman Brothers and the near-collapse of American International Group (AIG) led to a seizing up of financial markets and plummeting consumer and business confidence. Parts of the financial system froze, and assets once assumed to be completely safe, such as money-market mutual funds, became unstable and subject to runs. Credit spreads, a common indicator of credit market stress, spiked to unprecedented levels in the fall of 2008. The value of the stock market plunged 24 percent in September and October, and another 15 percent by the end of January. [O]ver the final four months of 2008 and the first month of 2009, the economy lost, on average, a staggering 544,000 jobs per month, the highest level of job loss since the demobilization at the end of World War II. Real GDP fell at an increasingly rapid pace: an annual rate of 2.7 percent in the third quarter of 2008, 5.4 percent in the fourth quarter of 2008, and 6.4 percent in the first quarter of 2009.” (ERP, 2010: 26-27)
Here is how President Obama himself described the crisis that greeted him when he took office:
“Last January, (2009) years of irresponsible risk-taking and debt-fueled speculation—unchecked by sound oversight—led to the near-collapse of our financial system. We were losing an average of 700,000 jobs each month. Over the course of one year, $13 trillion of Americans’ household wealth had evaporated as stocks, pensions, and home values plummeted. Our gross domestic product was falling at the fastest rate in a quarter century. The flow of credit, vital to the functioning of businesses large and small, had ground to a halt. The fear among economists, from across the political spectrum, was that we could sink into a second Great Depression.” (ERP, 3)
Later in the same message he noted that there were also long-term problems that his administration had to confront.
“At the same time, long before this crisis hit, middle-class families were under growing strain. For decades, Washington failed to address fundamental weaknesses in the economy: rising health care costs, growing dependence on foreign oil, an education system unable to prepare all of our children for the jobs of the future. In recent years, spending bills and tax cuts for the very wealthiest were approved without paying for any of it, leaving behind a mountain of debt. And while Wall Street gambled without regard for the consequences, Washington looked the other way.
As a result, the economy may have been working for some at the very top, but it was not working for all American families. Year after year, folks were forced to work longer hours, spend more time away from their loved ones, all while their incomes flat-lined and their sense of economic security evaporated. Growth in our country was neither sustained nor broadly shared. Instead of a prosperity powered by smart ideas and sound investments, growth was fueled in large part by a rapid rise in consumer borrowing and consumer spending.” (ERP, 5-6)
The Council of Economic Advisers elaborated a bit more on these long run problems:
“… even before the crisis, the economy faced significant long-term challenges. As a result, it was doing poorly at providing rising standards of living for the vast majority of Americans…Beginning around 1970, slower productivity growth and rising income inequality caused incomes for most families to grow only slowly. After a half-decade of higher growth in the 1990s, the real income of the typical American family actually fell between 2000 and 2006.” (ERP, 28)
As to what had caused the increase in inequality and slower productivity growth over the long run, the Council members were silent. They did, however, identify a rising share of debt-financed consumption as the problem for the decade since 2000:
“The expansion of the 2000s was fueled in part by high consumption. [T]he share of GDP that takes the form of consumption has been on a generally upward trend for decades and reached unprecedented heights in the 2000s. The personal saving rate fell to exceptionally low levels, and trade deficits were large and persistent. A substantial amount of the remainder of GDP took the form of housing construction, which may have crowded out other kinds of investment. Such an expansion is not just unstable, as we have learned painfully over the past two years. It also contributes too little to increases in standards of living. Low investment in equipment and factories slows the growth of productivity and wages.” (ERP, 29- 30)
Plan For Recovery: Success Or Failure?
In order to assess this issue, one must first explain how to judge success or failure. In the Economic Report of the President for 2017, Obama’s Council of Economic Advisers certainly argued that what they had done since January 2009 had been a great success. Here is how they argued:
“Over the two terms of the Obama Administration, the U.S. economy has made a remarkable recovery from the Great Recession. After peaking at 10.0 percent in October 2009, the unemployment rate has been cut by more than half to 4.6 percent as of November 2016 … Real gross domestic product (GDP) per capita recovered fully to its pre-crisis peak in the fourth quarter of 2013, … As of November 2016, the economy has added 14.8 million jobs over 74 months, the longest streak of total job growth on record. Since private-sector job growth turned positive in March 2010, U.S. businesses have added 15.6 million jobs. Real wage growth has been faster in the current business cycle than in any since the early 1970s.” [ERP: 2017: 21]
The forceful response of the federal government to the crisis in 2008 and 2009 helped stave off a potential second Great Depression, setting the U.S. economy on track to rebuild, reinvest, and recover. Everything the Obama Council of Economic Advisers marked in their 2017 Report is correct. Their emphasis on the importance of both the fiscal stimulus of the Recovery Act and the temporary payroll tax holiday as detailed in Figure 1-9 (pg. 35) from that report is not misplaced. Unfortunately, because of the political constraints on big deficits and the almost universal opposition of the Congressional Republicans, the Obama Administration had to be content with a fiscal stimulus which, though the largest in the post-World War II economy, turned out to be woefully insufficient.
Notice what was left out of the Council of Economic Advisers’ celebration of the successes of the post 2009 recovery? There was no sense of how the post 2009 period, the period of recovery according to the National Bureau of Economic Research’s Business Cycle Dating Committee, compared with previous recoveries from previous recessions. In general, it is essential that such comparisons be made across the board so that we can judge whether a particular set of policies was successful or not.
The economy did recover. By the time Obama left office in 2017, all economic indicators were significantly better than they were when he took office. If that is all the evidence that is needed then the economic policies of every President from Truman to Obama, except Jimmy Carter, George H.W. Bush and Donald Trump, represents an economic success story. The only reasons those might be considered failures is because unemployment was higher when they ran for reelection than when they took office.
Was the Recovery from the Great Recession a Relative Success?
Examining every recovery going back to 1961, they all showed an average Investment/GDP ratio above 17% except for the 1961-70 recovery where investment as a percentage of GDP was below that level. The recovery from the Great Recession was significantly lower than the previous recoveries averaging just over 16 percent. This does not fully capture the seriousness of the problem. When President Obama took office, the Investment/GDP ratio was 12.7% at the trough of the Great Recession. Unfortunately, unlike some earlier recessions when the ratio rebounded dramatically, it took three years between 2009 and 2012 for the ratio to reach 15.5%. It averaged only 16.2% of GDP for the entire period through the first quarter of 2017 and in fact never broke 18% until after 2017. The reason for the sluggish recovery of investment is easy to see; the fall in residential housing investment that had been the proximate cause of the Great Recession. If housing investment had just returned to that level, overall investment would have broken 18% significantly earlier. The extraordinary nature of the deep dive that occurred in investment and the growth of GDP called for a significantly bigger stimulus to aggregate demand than in previous periods. Government spending at levels similar to previous business cycle recoveries was not enough.
As a result of the slow recovery from the Great Recession, median incomes of ordinary Americans hardly budged and there was a high level of dissatisfaction within large swaths of the American people. Though there are many reasons for the surprise victory of Donald J. Trump in the 2016 election, one element that clearly contributed to it was the failed recovery from the Great Recession.
Bibliography
Council of Economic Advisers. (2010). Economic report of the President.
Council of Economic Advisers. (2017). Economic report of the President.
Krogstad, J.M. & Lopez, M.H. (2017, May 12). “Black voter turnout fell in 2016, even as a record number of Americans cast ballots.” Pew Research Center. Retrieved from http://www.pewresearch.org
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