The Economic Crisis: “How Did We Get Here?”
The most serious economic crisis since the Great Depression has exposed the failure of an obsolete economic growth strategy based on debt-fueled consumption.
The collapse of the U.S. housing bubble last year triggered a global credit crisis, and both events are now dragging the U.S. and other economies into a dangerous global recession. These are only proximate causes, however, and three underlying fundamental imbalances in our economy are ultimately responsible for producing the current crisis: an imbalance between the U.S. and the global economy; an imbalance between the financial sector and the real economy; and an imbalance in bargaining power between workers and their employers. All three imbalances must be corrected to restore an internationally competitive, sustainable U.S. economy in which prosperity is broadly shared. The proximate cause of this recession is the conjunction of a housing crisis and a credit crisis. The collapse of the U.S. housing bubble erased trillions of dollars of household net worth and undermined the solvency of under-capitalized financial firms. The difficulty in obtaining credit from troubled financial firms slowed economic growth and forced employers to shed jobs and cut wages. Meanwhile, consumers cut back sharply on spending as their wealth declined, further depressing economic activity. There is a fundamental underlying imbalance between the U.S. and global economies. An unsustainable external account imbalance requires the U.S. to borrow almost five percent of national income to pay for things we consume but no longer produce. This external imbalance has been sustained by Asian trading partners investing in dollar-denominated assets — such as U.S. Treasury bonds and mortgage-backed securities. This investment, in turn, maintained the exchange value of the dollar—and the competitive advantage of our Asian trading partners. Over the past decade, the trade surpluses of our Asian trading partners fueled a “global savings glut,” which helped inflate the U.S. housing bubble. If we as a country do not find a way to produce more of the value equivalent of what we consume, we will be forced — one way or another — to consume less. There is a fundamental underlying imbalance between the financial sector and the real economy. In a well-functioning economy, finance should serve the real economy by channeling savings to productive investment. But financial deregulation had the effect of diverting economic resources to the financial sector, away from productivity-enhancing investments in the real economy. There is a fundamental underlying imbalance between the bargaining power of workers and employers. This imbalance is largely responsible for the stagnation of wages over the past 30 years, which ruptured the relationship between productivity and wage growth and opened up a chasm of income inequality. One of the ways U.S. workers compensated for inadequate income growth was by incurring high levels of personal debt. For decades the U.S. has pursued an economic growth strategy based on low wages and debt-fueled consumer demand. Debt and asset bubbles temporarily masked the failures of this strategy, but those failures have been exposed by the current crisis. A fundamental imbalance between government and markets has exacerbated the other three imbalances. Financial deregulation (along with financial innovation) facilitated high levels of personal debt, then allowed the collapse of the U.S. housing bubble to trigger a global financial crisis. Government’s failure to enforce the rights of workers is a key reason for the growing imbalance in bargaining power between employees and employers. And unsustainable imbalances in the global economy can be traced to U.S. government policies on exchange rates, trade, and foreign investment that favored—rather than counterbalanced—the interests of transnational corporations, financial institutions, and the wealthy. This recession is not like previous recessions. Earlier postwar recoveries were brought to an end by policy decisions of the Federal Reserve to combat inflation by raising interest rates. The last two recoveries, by contrast, ended with the collapse of asset bubbles—of equities values in 2001 and of housing values in 2008-2009. The current deflation of housing values is far more serious than the deflation of equity values in 2001, and the current recession will certainly be much more serious. The policy tools that worked in past recessions will not work this time. In policy-induced recessions, the Federal Reserve could expect a reversal of policy — the lowering of interest rates — to generate economic growth in interest-sensitive industries. But interest rate cuts are unlikely to restart growth in the wake of asset deflation. Real interest rates are currently at historic lows, but have so far failed to power an expansion. Counter-cyclical fiscal policy is imperative, but the fiscal stimulus packages enacted in 2008 and 2009 were too small to counteract the combined effects of the housing bubble collapse and the global credit crisis. Any effective recovery plan must correct the fundamental underlying imbalances in our economy. This economic crisis is not an ordinary business-cycle downturn; it represents the failure of an obsolete economic model. We no longer have the option of perpetuating a failed economic growth strategy based on asset bubbles, low wages, and debt-fueled consumption. Correcting the imbalance between the domestic and global economy requires producing more of what we consume. U.S. competitiveness must be improved through public investment that creates a world-class workforce and a world-class transportation, information, and communications infrastructure. A public investment-led recovery program would bolster private investment and provide a basis for economic growth that is more sustainable than one based on high levels of debt and asset bubbles. Asian trading partners must also reform their extreme export-oriented growth model to consume more of what they produce and revalue their currencies.2 Correcting the imbalance between finance and the real economy requires regulatory reform of our capital markets. Re-regulation of our financial markets is essential to ensure the safety and soundness of insured, regulated institutions and to prevent the exploitation of investors and consumers.3 As a country we must devote fewer resources to financial speculation, and more of our resources to productivity-enhancing investments in green jobs, infrastructure, education, and health care. Correcting the imbalance in bargaining power between workers and employers requires labor law reform. The U.S. has no choice but to return to an economic strategy of broadly shared prosperity — a strategy that was remarkably successful in the first three decades of the postwar period. The Employee Free Choice Act (EFCA) would help reverse the growing imbalance in bargaining power between employees and employers, reconnect wages to productivity growth, and help rebuild the American middle class. Other necessary policy changes include an increase in the minimum wage and fiscal and monetary policies that promote full employment. The above article was written by Ron Blackwell, American Federation of Labor and Congress of Industrial Organizations (AFL-CIO). Footnotes: 1. In a White House meeting on September 18, 2008 after the bankruptcy of Lehman Brothers, President Bush asked his economic advisors, “How did we get here?” Jo Becker, Sheryl Gay Stolberg, Stephen Labaton, “White House Philosophy Stoked Mortgage Bonfire,” The New York Times (December 8, 2008). 2. AFL-CIO Executive Council, “China Trade: Beggars and Neighbors,” (March 3, 2009). 3. AFL-CIO Executive Council, “Financial Regulation,” (March 5, 2009).
