E CONOMISTS are hardly renowned for their ability to predict the economic future. In 1929 Irving Fisher, perhaps the greatest of all American economists, confidently predicted that the stock market would go on to new highs and that the expansion of economic prosperity would continue, with no end in sight. Less than two months later came the crash; the economy had already entered what was to become the Great Depression. Published in 1987, Ravi Batra's best-selling The Great Depression of 1990 predicted just what the title says. So much for predictive accuracy.
Compounding the problem of prediction is the tendency to believe that each business-cycle boom will last forever -- that the business cycle is dead. Predictions of when the next recession will occur aside, however, there are now solid grounds for believing that the economy is again vulnerable to the sort of seismic shock that generated the Great Depression. The period from 1950 to 1970 is often referred to as the Golden Age of American capitalism. Real per capita income grew in those years at 2.25 percent a year, and prosperity was democratized as huge numbers of Americans entered the middle class. Indeed, a new working-middle class was created, as blue-collar workers came to enjoy the benefits of homeownership, and rising wages allowed them to buy household appliances and new cars and to take vacations.
Since 1970 this expansion and diffusion of prosperity has stopped, and the Golden Age has been replaced by a Leaden Age, in which economic growth has been accompanied by falling wages and rising unemployment. Real (in terms of purchasing power) average weekly wages peaked in 1973, at $308.03 (1982 dollars), and by 1991 had fallen to $260.37, a decline of 15.5 percent. Yet the productivity of American workers increased by 11 percent over the same period. From 1951 to 1974 unemployment averaged 4.65 percent; from 1975 to 1993 it averaged 6.97 percent.
This waning of prosperity reflects a shift from the Main Street capitalism of the Golden Age to the Mean Street capitalism of the Leaden Age. The hallmark of the former was that it generally worked for the benefit of the average citizen by sharing the fruits of growth among all. The hallmark of the latter is an economic environment that pits citizen against citizen for the benefit of those who own most of America. This shift is the direct result of a refashioning of the nation's economic architecture and a reversal of the policies associated with the Golden Age. It has opened the possibility of another Great Depression.
Since the Second World War the U.S. economy has had nine recessions, defined as two consecutive quarters of declining output. The normal pattern has involved an increase in the rate of unemployment and also "disinflation" -- a decrease in the rate of inflation. The most severe of these recessions was that of 1981-1982, when unemployment exceeded 10 percent for the first time since the 1930s. The most recent recession, which began in 1990, appears to be qualitatively different from preceding recessions in that the subsequent recovery has been much milder, and the process of disinflation has continued throughout the recovery period. Thus, rather than picking up, inflation has continued to fall during the recovery, and we now have close to zero inflation. This means that were the U.S. economy to enter a new recession, it would be likely to experience deflation: prices and wages would actually fall. Were this to happen, the burden of interest payments on the debts of consumers and businesses would increase enormously, thereby making for a collapse of both consumer spending and capital spending by businesses.
It is for this reason that deflation has historically been associated with periods of economic depression. A reasonable definition of depression is a period of prolonged unemployment in excess of 10 percent accompanied by deflation. The recession of 1981-1982 showed that rates of unemployment in excess of 10 percent are again possible, whereas the most recent recession has raised the specter of deflation. The twin characteristics of depressions are therefore now potentially in place. Behind this new circumstance lie the changed conditions associated with the emergence of the Mean Street economy. The high level of indebtedness in the U.S. economy implies that if prices and wages start falling, spending and fresh borrowing will most likely collapse, and bankruptcies will rocket. The economy could then find itself in a contractionary spiral, with wage deflation feeding a collapse in spending, and collapsing spending feeding further wage deflation.
ONE indication of our growing economic fragility is the recession of 1990. The accepted story is that the Iraqi invasion of Kuwait and the ensuing spike in oil prices gave a sudden shock to the confidence of American consumers, damping their spending and pushing the economy into recession. This recessionary shock was amplified by the large debts that American households and corporations had built up during the 1980s.
Whereas the role of debt in propagating the recession was real and important, the consumer-shock story resembles the snowball theory of avalanches. Moreover, it illustrates the complete confusion that characterizes modern economics. On the one hand, consumers are told to spend, spend, spend! On the other, they are told to save, save, save! Similarly, whereas huge consumer debt burdens are an important component of the new economic fragility, their existence is explained by developments associated with the shift to the Mean Street economy. Debt, therefore, is both a symptom and a cause of our troubles.
Just as the causes of the 1990 recession have been poorly explained, so have its prolonged nature and the weakness of the subsequent recovery. Economists consider the recession to have ended in the first quarter of 1991, but substantive recovery did not really begin until the second half of 1993. Thus for almost three years the economy was effectively dead in the water. This kind of prolonged stagnation distinguishes the current recovery from previous postwar economic cycles. Moreover, the economic recovery has been extremely anemic by postwar standards. In the fifty months after the trough of the recession, in late 1990, the economy created 7.8 million jobs. That is 40 percent below the average rate of employment growth in the first fifty months of the previous two economic recoveries.
Throughout this period of putative recovery consumer confidence has been notably weak. Income data for 1994 show that real median wages fell by more than two percent. Thus the median household actually suffered a decline in its standard of living. Not only has income been falling, but job security has declined as corporate downsizing continues. The threat that production will be relocated to low-wage regions, both within and outside the United States, is a persistent and growing source of wage restraint.
FOREMOST among the causes of the prolonged 1990 recession and its subsequent weak recovery is an underlying deterioration in the robustness of the demand for goods and services.
The silent depression (the erosion of wages and the increase in unemployment rates) afflicting ordinary American households has weakened consumer purchasing power and shifted income away from wages and toward profits and executive salaries. This, more than anything else, has created a structural weakness in demand. This development has been obscured, and its impact delayed, by the tremendous growth of household debt that began in the 1980s.
Expansion of household debt has always been an important source of demand growth in the U.S. economy, paving the way for expansion of the mass market. In past decades, however, household borrowing rested on a presumption of rising incomes to pay it back, and was therefore "demand-leading." Today, with wages declining, debt is being incurred simply to maintain existing living standards. "Demand-leading" debt has become "demand-maintaining." Because new borrowing causes a cumulative growth in household indebtedness and raises the interest payments debtor households must make, indirectly, to creditor households, the demand-maintaining capacity of new borrowing is unsustainable. In general, low- and middle-income households are net debtors, while high-income households (of which there are few) are net creditors. Consequently, demand-maintaining borrowing aggravates the underlying problems of weak demand and unequal income distribution.