America's Upside-Down Economy

The most alarming possibility about the faltering US recovery is that economic traits once regarded as strengths might have become poisonous. By European standards, the US has a low-friction labor market. Workers are let go quickly in downturns then quickly rehired in the upswing. The drawbacks are obvious but, the argument has always gone, flexibility and mobility have made the economy more adaptable--so growth has been good and structural unemployment low (again by European standards). On balance, the low-friction US labor market has been a strength, and will be again once the recovery gets better established. So goes the conventional view.

The particular characteristics of the Great Recession put this in doubt.

The depth and duration of the slowdown have pushed long-term unemployment in the US way up, which may permanently erode the employability of workers. Mobility is restricted by the overhang of negative equity in the housing market, which makes it far harder than usual for many unemployed workers to up and move. Most frightening is the possibility that excess household debt may have bent the economy's aggregate demand curve backwards, so that supply-side improvements that once would have powered growth--higher productivity, for instance--may actually shrink the economy. Paul Krugman and Gauti Eggertsson drew attention to this scenario in a paper last year. The recent slowing of the recovery demands that it be taken very seriously.

I go into a bit more detail in this column for the FT: America flirts with a fate like Japan's. (The article also mentions a new paper by Robert J Gordon. As yet I don't have a link for that, but here is a link to an earlier version: The Demise of Okun's Law and of Procyclical Fluctuations in Conventional and Unconventional Measures of Productivity. I'll update it later.)

A new Robert Samuelson column, the Great Jobs Mismatch, is also relevant.