The fragility of the US economy

While the US has registered continuing growth since the 2008 financial crisis, this has been by far the slowest recovery in its postwar history. The fact is the economy suffers from some serious structural problems which, if not addressed, may yet plunge it into a deep crisis.

Dimitri B Papadimitriou, Michalis Nikiforos and Gennaro Zezza

LAST year saw another year of continued growth for the US economy. Gross domestic product (GDP) expanded and the unemployment rate decreased to 5% in the last quarter of 2015, its lowest level since the beginning of 2008 and the start of the global financial crisis. The growth recovery and the decrease in unemployment led the US Federal Reserve to change course and increase the federal funds rate in December 2015. This was the first increase in the federal funds rate in almost 10 years, and it carried the implicit expectation that there would be further tightening in the near future.

However, the current US recovery, now well into its seventh year, is like no other. The Federal Reserve press release announcing the rate hike was extremely cautious, and many economists - including ourselves - have warned about the possibility of an extended period of secular stagnation. Dissatisfaction with the performance of the US economy is dominating the 2016 presidential primaries: despite the relatively low 5% unemployment rate, the principal concern of voters and most of the candidates is 'economy/jobs' (as it appears in the questionnaires of those conducting the various polls).

It is not hard to understand this dissatisfaction. This has been by far the slowest recovery in the postwar history of the United States. Compared to its pre-crisis peak in the fourth quarter of 2007, real GDP is only 11% higher (as of 2015Q4). Similarly, the number of employed civilian workers in December 2015 was only 3.3 million higher - representing an increase of 2.2% - than the corresponding employment level in November 2007, the peak of the previous cycle. Finally, the civilian-employment-to-population ratio is now only 1% higher than its trough after the crisis (2009Q2). This improvement took place between October 2013 and December 2014, and has since effectively stopped. The last time the employment-population ratio was at the current level was in April 1984.

In addition, the recent downturn in Brazil and Russia, the economic slowdown in China and the crash of the Chinese stock market (the Shanghai Stock Exchange Composite Index is now 44% lower than it was last June), and, more generally, the fragile condition of the global economy - especially the economies of US trading partners - pose another challenge for the US economy and threaten the already anaemic recovery.

The weak foreign demand for US exports is further dampened by the appreciation of the dollar. In the course of the last one and a half years, the broad trade-weighted nominal exchange rate of the dollar has appreciated more than 25%.

An important exception to the poor overall performance of net exports during the current recovery is the net export of petroleum products. The extraction of shale gas, together with the drop in the price of oil, has led to a very significant improvement in the trade of petroleum products. Shale gas extraction has also contributed to aggregate demand through investment. However, the benefits from the oil market downturn seem to have been exhausted. The price of oil is now so low that new shale gas projects are not profitable, and there is little room for improvement in the trade of petroleum products.

Moreover, there are indications that the instability in the financial markets can spread to the developed economies, even the United States. The last couple of months have witnessed significant drops in the stock markets of Europe and the New York Stock Exchange. Still, the S&P 500 Index is far above the levels of early 2000 and 2007, and it is hard to see how the 'fundamentals' of the US economy justify that (in the same way that they did not then).

However, we should not arrive at the hasty conclusion that the fragility of the US economy emanates from some exogenous shocks in foreign demand or the financial markets. At its core, the US economy remains fragile because of three deeply rooted structural characteristics.

The first is the weak performance of US net exports. Starting in the mid-1980s, but especially since the 1990s, there has been a successful invasion of American markets by foreign products, increasing imports and the current account deficit. Net exports of petroleum products in the period 2011-15 are the one serious exception to this. Had it not been for the improvement in the trade balance of petroleum products, the United States' overall trade deficit would now be at its pre-crisis level of more than 6% of GDP. This problem of unbalanced trade is now exacerbated by the slowdown in the emerging markets, stagnation in the rest of the developed economies and the appreciation of the dollar. The existence of this structural external deficit makes the achievement of a satisfactory growth rate for the economy and full employment dependent on the accumulation of domestic deficits, public and/or private.

Second, over the last 25 years policymakers in Washington have become increasingly fiscally conservative. The current recovery is the only one in the postwar period during which government expenditure has decreased in real terms. Fiscal austerity, together with weak foreign demand, has put the entire burden of supporting aggregate demand on the private sector spending in excess of its income and borrowing. This has led to a rapid increase in the private sector debt-to-income ratio in the United States.

This process is facilitated by asset inflation because rising asset prices make the balance sheets of debtors (and creditors) look better, enabling them to further increase borrowing and pushing debt-to-income ratios higher. Moreover, nominal increases in wealth also have a direct positive effect on consumption and aggregate demand. In that sense, the expansion of the 1990s was supported by the (hyper)inflated stock market of that period, and the expansion of the 2000s was supported by the recovery of the stock market together with the real estate market boom. Accordingly, the current recovery (weak as it is) has been supported by an extraordinary increase in stock prices. Therefore, a 'correction' in the stock market will have a seriously negative impact on growth and employment.

The third serious structural problem in the US economy is the increase in income inequality over the last four decades, which has continued uninterrupted after the crisis. Besides the serious political ramifications it has, the increase in inequality also has dire macroeconomic consequences. The transfer of income shares from the middle class and lower-income households towards households at the top of the income distribution is a serious drag on demand, since the saving rate of the latter is much higher than that of the former.

Moreover, the aforementioned increase in the debt-to-income ratio falls unevenly on households at the bottom of the distribution. In a previous report, we showed that the debt-to-income ratio of the household sector as a whole increased from 0.6 in the mid-1980s to 1.1 on the eve of the crisis in 2007. This already striking increase - related to the developments in the foreign sector and the fiscal stance of the government - was unequally divided between the bottom and the top of the distribution. In the top 10% of the distribution the ratio remained virtually unchanged at a low level, fluctuating around 0.5, while households in the bottom 90% saw their debt-to-income ratio increase from 0.7 to 1.6 in 2007. This uneven distribution of debt has the dual effect of making the economy even more unstable while dampening aggregate demand when over-indebted households try to deleverage in periods like the current recovery.

Thus, the fragile prospects for the US economy are not the result of some exogenous shock but are, rather, based on inherent characteristics of the economy and need to be primarily understood in terms of these three basic structural problems: (1) weak foreign demand for US exports, (2) fiscal conservatism, and (3) income inequality. It is these structural problems that are now being compounded by the weak economic performance of US trading partners, the appreciation of the dollar and the possibility of a contraction in asset prices.

Therefore, achieving sustainable economic growth in the United States requires, first and foremost, addressing these fundamental issues: a decrease in income inequality, international cooperation to rebalance the global economy and improve the US external position, and relaxation of the government's fiscal stance. The alternative is a future of secular stagnation or debt-driven recoveries that will result in increasingly severe financial and economic crises.                 

Dimitri B Papadimitriou is President of the Levy Economics Institute of Bard College in the US. Michalis Nikiforos and Gennaro Zezza are Research Scholars with the Levy Institute. The above is extracted from 'Destabilizing an unstable economy', a Strategic Analysis (March 2016) published by the Levy Institute. The full paper with references is available at

*Third World Resurgence No. 307/308, March/April 2016, pp 50-51