Will the Economy Return to Normal... Assuming Anyone Can Figure Out What That Means

Normal? The new normal? A return to normal? All of these phrases are based on a huge and utterly unsubstantiated presumption: that there is a normal anymore. And, even if we could identify it, that we possess the mechanisms to return to it, achieve it - and stay there long enough for it to matter. Other than that, it sounds totally doable... JL

Tyler Cowan comments in the New York Times:

Institutional rigidities don’t permit adjustments to occur all at once. It is difficult to be sure when a reset is underway, and it is harder yet to raise public alarm about changes that seem to be gradual and slow.

It is hard to avoid the feeling that our current economic problems are more than just a cyclical downturn. We know that the economy has gone through some bad times. But what exactly are we experiencing?

One relatively optimistic view is that observed deficiencies — like slow growth in real wages and the overall economy, persistently low interest rates and low levels of labor participation — are merely temporary. In this view, these problems will dwindle after manageable problems like high levels of public or household debt have been reduced.

Another commonly heard view is that we made the mistake of letting the last recession linger too long, allowing some of its features to became entrenched. That analysis suggests that if we correct past policy errors, whatever they may have been, an underlying normality will re-emerge.

There are some nuggets of truth in both of these arguments, but there is a much more disturbing possibility that could turn out to be more accurate: namely, that the recession was a learning experience that we haven’t fully absorbed. From this perspective, the radical and sudden changes of the financial crisis were early indicators of deep fragility and dysfunctionality.

Slowly but surely, we may be responding to these difficult revelations by scaling back our ambitions for the economy — reinforcing negative trends that were already underway. In this troubling view, we have finally begun to discover some unpleasant truths. Borrowing a phrase from the University of Toronto economist Richard Florida, it’s possible that we are experiencing a “Great Reset.”

Let’s consider an analogy to see how this might work in practice.

Well before the recent recession, many colleges and universities realized that they could not afford so many full-time tenured and tenure-track faculty members, and they began to increase their reliance on lower-paid adjuncts. Few institutions fired large numbers of full-timers suddenly, because that could have left them understaffed if trends reversed. Longstanding protections of tenure were also a constraint. Instead, many administrators added modestly to the number of adjunct faculty members, sometimes over decades, relying on retirement and attrition to manage the shift in a relatively smooth manner.

That evolution reflects a more general principle: Institutional rigidities don’t permit adjustments to occur all at once, but by studying continuing changes we may be able to peer around a corner and see where a sector is headed.

Such processes are scary because we may be watching the slow unfolding of a hand that, in its fundamentals, has already been dealt.

There are signs that a comparable story may apply to the American economy more broadly.

In manufacturing, for example, Ford, Chrysler, General Motors, Caterpillar and Navistar (formerly International Harvester) all pay many of their new workers much less. In some of these two-tier structures, the new wage may be as little as half the old one. In addition to this rapid change, the companies also seem to be reducing the ranks of highly paid workers through slow attrition.

Here is another change that might be a broader sign of a pending reset: A heavy burden of adjustment in the overall labor market is being borne by the young. Wages for the typical graduate of a four-year college have dropped more than 7 percent since 2000, and the labor force participation rate of the young has been falling. One consequence is that young people are living at home longer and receiving more aid from their parents. They also seem to be less interested in buying their own homes.

All of these factors could indicate that our economy is evolving into one that will offer far less favorable long-run wage prospects. Much research has shown that the effects of a recession can be pernicious for decades: Earning a lower wage in earlier years is predictive of lower wages through the rest of one’s career. While we are seeing economic problems for the relatively young, they will eventually become dominant earners in the economy and the major force behind broader statistics.

In short, are these economic problems transitory, or are we glimpsing the beginnings of a grimmer future?

If a reset is underway, we might have to accept that public policy cannot reverse it easily. Once unsustainable economic structures begin to fail, it takes a significant improvement to make them viable again. Yet because of the difficulty of making major changes under our current political alignment, most new government policies today are no more than changes at the margin. Perhaps the most basic problem is that it is difficult to be sure when a reset is underway, and it is harder yet to raise public alarm about changes that seem to be gradual and slow.

Most of all, it is not always wise to fight a reset.

Early in the previous decade, Germany realized its economic model wasn’t working, and it accepted lower real wages for many workers.

Even though growth in living standards has been slow, the German economy has been flexible and has appeared to be on a sustainable track. Maybe that was the best Germany could do.

France, in contrast, has attempted to preserve high real wages and benefits for prime-age workers, in part by buying older workers out of employment and delaying starts for the young. But the country has a higher rate of unemployment and, arguably, may face greater and more sudden adjustments in years to come. French polls indicate high pessimism about future economic prospects.

The debate over the economy these days isn’t just about income inequality and what should or should not be done about it. Perhaps the most crucial issue is whether economies will return to normal conditions of steady growth, or whether we are witnessing a fundamental transformation, unveiled in bits and pieces. Nominations for the nature of that transformation include a “robot economy,” a new political economy where elites have too much power or, perhaps, a new global economy where the United States no longer holds such a dominant position, to the detriment of American firms and workers.

No one knows whether or how much of a reset may be underway. Yet I can’t help but wonder which features of current data might prove harbingers of larger, more permanent changes to come.