Washington D.C. is a city that runs on spin. Never is this phenomenon more apparent than in an election year or during the waning years of a politician’s term. The desire to solidify one’s legacy often leads to revisionist thinking, hyperbole and exaggeration, or diffusion of blame. With the current administration entering its final two years, and the early onset of the next presidential campaign, I thought it might be interesting to bypass the rhetoric and concentrate on what Sgt. Joe Friday used to call “just the facts.” What does the data say about the Obama economy and how will it shape his economic legacy?
Comparing economic performance over presidential terms is always tricky. If a presidential term does not coincide with the economic cycle, then what is the proper time frame to attribute to that particular president’s record? How should one handle an “inherited” recession or expansion? How can one attribute blame or responsibility for policies initiated in prior administrations? All these problems notwithstanding, we still see comparisons of economic performance and they are still interesting to look at provided we don’t take them too seriously.
I chose to look at just one phase of the economic cycle, the recovery or expansion phase, and to compare the current recovery to others in the post-WWII era. The current recovery began in mid-2009 and is currently just over 6 years old and, based on forecasts from a broad range of forecasters, is expected to continue for some time. So it may not be completely fair to compare it to completed expansions of the past, but let’s do it anyway.
Let’s start with the most comprehensive measure of the economy, Gross Domestic Product (GDP). Since mid-2009, the economy adjusted for inflation has grown at a 2.1% annual pace. This pace places it as the worst economic recovery in the post-WWII era – slower that the 2.8% rate of the George W. Bush recovery, the 3.6% rate of Bill Clinton’s recovery or the 4.3 % pace of the recovery during the term of George H. W. Bush.
Another important metric for an economy is productivity growth. Most economists believe that productivity growth is important for wage growth, an improving standard of living and a stronger potential rate of economic growth. Since mid-2009, productivity growth has averaged 1.0% at an annual rate. This pace is not only the slowest of any expansion in the post-war era but is less than half the rate of growth of any expansion except for the expansion following the 1974 downturn which averaged 1.7%.
While comparisons to prior periods are interesting, sometimes it is important to compare the economy’s performance to an absolute standard. The above chart compares the actual performance of the economy to its potential rate of growth. Potential growth is the rate at which the economy could grow over time while using all its resources to their fullest advantage while maintaining price stability. It is the rate at which the economy could grow while maintaining full employment and stable inflation – sort of a best case scenario.
In theory, potential growth reflects productivity growth and the growth in labor inputs which underscores why productivity growth is so important. The Congressional Budget Office (CBO) provides estimates of the economy’s potential rate of growth. The economy’s actual rate of growth tends to oscillate around the long-run potential rate of growth, rising faster than potential in economic expansions and falling below its potential during contractions. This oscillation is called the business cycle.
In the most recent downturn, the economy fell well below its potential (another way of saying this is that the economy built up a large negative GDP gap), but unlike prior post-war cycles this time the economy has so far failed to accelerate during recovery and close the GDP gap or regain its long-run potential.
The average length of time that the economy has taken to regain its long-run potential in the eight post-war recoveries has been 11.5 months. We have been in recovery for over 72 months and have not yet regained our potential. Fully six years after the end of the recession, our economy has yet to regain its potential and is still operating with a negative GDP gap.
Indeed, the main reason why the negative gap has closed at all is not that the economy accelerated but rather that the potential rate of growth has slowed. This is akin to an athlete doing pull-ups by pulling the bar down to his chin rather than pulling himself up to the bar. The CBO estimates of potential growth over the years of the Obama presidency were originally presented by Lawrence Summers, a Harvard professor and advisor to both President Clinton and Obama. CBO has been forced to revise its estimate of potential growth lower in each year of the Obama administration.
In its latest mid-year review, CBO estimates that at projected GDP growth rates, the economy will close the negative gap to its historical average by the end of 2017 but never quite reach its potential. Even this modest achievement assumes that GDP growth accelerates to 3.1% in 2016 and 2.7% in 2017, stronger growth than our economy has been able to achieve in any year since the end of the recession.
This point really cannot be emphasized enough. According to CBO, the economy will fail to close the GDP gap at any time during their 10 year projection. That means the economy will have operated for over 15 years with a negative GDP gap. Is it any wonder why people still feel like we are still in a recession?
Many administration apologists blame the long and deep recession for this weak performance but history suggests that is a hollow excuse. Recessions and recoveries usually exhibit some symmetry, that is steep declines are followed by rapid ascents. After the very steep and long recessions of 1974-75 and the double dip recession of the early 1980s, growth in the first three years of recovery was very strong allowing for a quick return to potential.
Weak growth in productivity and economic output are often associated with weak wage and income growth and that is true this time around as well. Growth in real compensation and real per capita disposable income has been historically weak in this expansion. Growth in real compensation in this recovery was slower than in any recovery in the post-war era except for the very short period between the two recessions of the early 1980s. Growth in real per capita disposable income is lower by half of any post-war recovery.
One area that the Obama administration cites often as a success story is the labor market and job growth. But even here a closer look exposes more than a few warts. Job growth has averaged just over 210,000 per month this year and the unemployment rate is down to 5.3%. However, if one looks at the broader U-6 measure of underemployment, the number is still close to 10 ½% and the number of workers not even looking for work is still above 1.9 million, well above its pre-recession level. The average monthly job growth during this recovery has been about 150,000 per month above what we saw during the George W. Bush recovery but less than the pace during any of the recoveries from 1958 through 2001. When one adjusts for the size of the workforce in each of these time periods, this pace of job growth is lower that any post-war recovery except which occurred from 2001 to 2007. Moreover, the participation rate has dropped to level not seen in almost 40 years. And as the president’s own Council of Economic Advisers has pointed out, only about half the drop in the participation rate can be attributed to demographics, meaning the rest is due to broader current economic conditions.
Citing data provided by French economist Thomas Piketty, a major focal point for this administration has been income inequality, ignoring the critiques of Piketty’s work, which demonstrate the apparent growth in inequality largely disappears when one adjusts the data for changes in size of family, taxes paid, transfer payments received and uses a more appropriate chain weighted price index. When one looks at a well-known measure of income such as the census data on household income, and calculates a commonly used measure of inequality known as a Gini coefficient, the Obama administration’s performance on income inequality does not fair particularly well. The Gini coefficient measures the degree of inequality with 0 being perfectly equal and 1 being perfect inequality. The Gini coefficient has been rising since the 1970s indicating growing inequality.
A quick review of the data shows that in past episodes inequality grew more during periods of rapid expansion such as the Reagan or Clinton expansions, and grew more slowly during periods of more modest growth. Thus, one might expect that the historically weak recovery overseen by President Obama might have seen less of an increase in inequality. But the data suggest this is not the case. Inequality as measured by the Gini coefficient actually increased more during the Obama years that during the Bush Administration.
The relatively poor performance of the Obama recovery is somewhat surprising given the expansive level of fiscal and monetary policy during much of this time. This administration ran huge deficits both in absolute terms and relative to the size of the economy during much of its first term and more than doubled the level of federal debt outstanding. Moreover, CBO estimates that after a short hiatus deficits and debt will begin to grow again in no small way pushed by growing interest costs on the debt already incurred. Monetary policy has also been aggressively accommodative, with interest rates held at or near zero for a prolonged period of time and an increase in the Federal Reserve’s balance sheet of over $4 trillion dollars.
So why has the economy performed so abysmally this time around? Could it be the explosion of new regulations, the enactment of largely unpopular health-care reform, the passage of restrictive financial services reform, the failure to pass an energy program, or the uncertainty brought about by a combination of the above? The answer to those questions will have to wait for a future post.