R E S O L U T I O N o f U N C E R T A I N T Y i s t h e K E Y f o r 2 0 0 3
-- Rajeev Dhawan
Director of the Robinson College of Business
Economic Forecasting Center
War clouds are looming on the horizon, and it's not clear when the Iraq offensive will begin. Perhaps it will have already reached a successful conclusion by the time this article hits your desk. But what if it doesn't? North Korea has become a very painful thorn in the side of the administration as it prepares to tackle Iraq and other associated geopolitical problems. The domestic economy is not adding any new jobs. Last year, we lost close to 180,000 jobs even though the GDP growth was positive. This jobless recovery, or nonrecovery as I would like to term it, is not at all conducive for new job market entrants. Just ask my recently graduated MBA students how their job searches are going. The same is true with other schools such as Harvard, UCLA, Duke and Wharton, which have not been able to find jobs for more than 80 percent of their recent grads.
What is going on over here? History and the models based on it predict that job growth and economic recovery need to go hand in hand. There can be delays, as seen in the early '90s when there was a jobless recovery. At that time, the technological revolution was still in its infancy and the banking sector was still reeling from the effects of the failed savings and loan crisis. Then, the lack of job growth could squarely be blamed on the not-so-healthy balance sheets of the participants - businesses as well as the banks. Long-term interest rates were much higher as was the inflation rate, with strong deficits as far as the models could project. The Federal Reserve initially was fighting the battle against inflation and was accused (unfairly, in my opinion) of being slow in cutting rates.
Then came productivity growth related to telecoms, computers, the World Wide Web and dot coms (yes, they were a very critical vehicle in risk sharing). Any time there was a whiff of financial trouble, crisis in the bond market or if the believers of NAIRU (read old economy supply-side constraint believers) came marching, our savior Greenspan rode to the rescue of the stock market believers. Then, as it happens in any good story, the bubble burst - rightly so but maybe a bit delayed for the young 20somethings. However, in the post-NASDAQ 5,000 levels, we have been unquestionably left with "real" productivity gains. These are solid, easy to observe in day-to-day life and not vanishing anytime soon.
My wish for 2003 is for the administration to either finish with the war soon or stop talking about it. Resolution of war uncertainty is the key to the recovery scenario I envision.
So what is the problem right now? We are at this moment witnessing the dark side of productivity improvements of this new era. This is when less people can be used to produce the same level of output. A corollary of this logic is that businesses can crack their whips or intensively use their existing or reduced labor force to produce even more in the short run. Productivity by itself doesn't ask for more people to be hired. The scale of corporate operations is expanded if and only if companies perceive future aggregate demand to exist and be stable. This is the trouble now. War drums coupled with terrorism fears are keeping executives from taking the "additional" risk of expanding their operations. Hence, no hiring or even a reduced scale of operations to please the profit rate police.
I don't blame the CEOs and their boards. They have a justifiable excuse they canšt bank upon future demand because we donšt know when this war will begin and end or if it will spread to other regions in the Middle East. On the other side, the corporate scandals of the past 12 months have reduced the trust that the common investor has in them. This has shown up in higher risk premiums being charged to companies that are not rated AAA (e.g., 99.9% of all firms in operation). This risk premium can't be wished away since it is independent of the super low short-term rates.
My wish for 2003 is for the administration to either finish with the war soon or stop talking about it. Resolution of war uncertainty is the key to the recovery scenario I envision. Once this uncertainty is resolved, we need a dose of fiscal stimulus to jump-start the entire system's decision-making process.
Bush's proposed fiscal stimulus plan does that to some extent. I like the elimination of double taxation of dividends as a way to bring back the faith of common investors in the workings of the market. Corporate governance reforms are needed, and this is a very direct way of doing just that. It takes away the excuse of firms whose retained earnings are more than shareholders would have desired. Once the interests of both parties are aligned, it will foster more faith or reduced risk premiums, and generates future growth. The cost of this cleanup is minimal in my view. Deficits by themselves are not bad things, and there is no "magical" limit in economics on them. What matters is that if deficits are done when the economy is running full steam, it will lead to a higher inflation premium in rates. In 1999, I would have been less enthusiastic, but this is 2003 and we are running at a 6.0 percent unemployment rate, low by historical standards but much higher given the economy's potential.
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