Destabilizing an Unstable Economy - The Market Failures Issue

Challenge, Nov-Dec, 2002 by Charles Whalen, Jeffrey Wenger

The ELR notion is similar to New Deal jobs programs such as the Works Progress Administration and Civilian Conservation Corps, but ELR would be permanent. As Minsky wrote, this program would be "operating at a base level during good times and expanding during recession" (Minsky 1986, 308). ELR allows the government to establish a "buffer stock of labor," one that can counteract both unemployment and inflation (Wray 1998, 543).

Finally, there is one idea that could destroy government's ability to make use of automatic stabilizers: the notion that there should be a balanced-budget amendment to the U.S. Constitution. Such an amendment has often gained much popular and political support--and it may again receive attention in the next few years, as legislators in both parties try to stop a return to deficits "as far as the eye can see." But this amendment would force tax increases or spending cuts in the midst of a contraction--moves that would worsen the downturn. And there would not be an increase in government debt as needed to provide the portfolio benefits described earlier. These dangers should to be kept in mind by those interested in making the economic system more stable.

The Surprise Economy?

If the built-in stabilizers of the U.S. economy have eroded in recent decades, why has the latest downturn not been much more severe? Many media commentators have suggested that the recession that began in March 2001, as determined by the National Bureau of Economic Research (NBER), has been rather mild. But that is not entirely true. And there was an unusual combination of policy actions and economic conditions that kept the contraction from getting worse during much of 2002.

Not So Mild

In many respects, the downturn that ended the 1990s boom has indeed been consequential. Consider the following.

The economy experienced a dramatic change in direction between late 1999 and early 2001. After growing at an annual rate of over 7 percent in the last quarter of 1999, and still expanding at nearly 5 percent in mid-2000, GDP contracted in the first three quarters of 2001 (U.S. Department of Commerce 2002).

The stock market suffered severe losses in both the year before and the year after September 11, 2001. In the twelve months prior to the terrorist attacks on New York and Washington, DC, the Standard & Poor's 500 (S&P) lost more than 25 percent of its value, the Dow Jones Industrials dropped 15 percent, and the NASDAQ fell over 55 percent. In the twelve months following the attacks, the S&P and Dow again lost roughly the same amount, while the NASDAQ fell 27 percent ("Figures of the Week" 2001-2002).

Capital spending, which fueled the 1990s expansion, collapsed in late 2000--along with the revenue of many telecommunications and information-technology companies. Business spending on capital equipment grew by 15 percent a year, on average, from 1997 to mid-2000. Then it contracted for six quarters in a row, starting with the fourth quarter of 2000.

Profits took a similar path. In the last quarter of 2000 and the first quarter of 2001, earnings for the 900 companies in BusinessWeek's Corporate Scoreboard took double-digit tumbles from a year earlier. The Scoreboard then posted record-breaking profit declines in each of the next four quarters, culminating in a stunning 56 percent fall in the first quarter of 2002 ("Corporate Scoreboard" 2001-2002).