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Analysis/Comment Last Updated: Mar 29, 2011 - 2:42 PM

Dr. Peter Morici: The Gathering Strom: US economy remains too vulnerable
By Professor Peter Morici
Mar 29, 2011 - 4:25 AM

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President Barack Obama talks with Tommy Vietor, Senior Director and National Security Staff Spokesman, left, and Ben Rhodes, Deputy National Security Advisor for Strategic Communications, in the Outer Oval Office, March 28, 2011.

Dr. Peter Morici: The US economy picked up in the first quarter. After adding 175,000 jobs in February, economists expect the Labor Department will report on Friday that the economy added 188,000 jobs in March. However, events in Japan, Libya and the wider Middle East, and the European sovereign debt crisis threaten to reverse these gains and thrust the economy into a second recession.

Longer term, job gains in the range of 200,000 a month are not enough to push unemployment down to acceptable levels. Dysfunctional energy, trade and tax policies are holding back US growth, adding to unemployment and lowering wages.

Private Sector Jobs

Until February, the private sector was creating few permanent jobs. Most jobs were either in health care and social services, which enjoy heavy government subsidies, or temporary business services. Excluding those activities, the “core” private sector gained 170,000 jobs in February; whereas during the prior 13 months, the average gain was only 45,000.

Core private sector jobs have the potential to set off a virtuous cycle of hiring, consumer spending and more hiring, but after such a deep recession, 170,000 jobs per month is simply not enough.

The economy must add 13 million private sector jobs over the next three years—360,000 each month—to bring unemployment down to 6%. Core private sector jobs must increase at least 300,000 a month to accomplish that goal.

Growth at three% will only keep unemployment steady, because the working age population increases one% a year, and productivity advances about two%. Growth in the range of 4 to 5% is needed to get unemployment down to 6% over the next several years.

Prior to the turmoil in the Middle East, economists were forecasting 3.5% growth for 2011, but the surge in oil prices and gasoline at $3.60 per gallon will likely shave half a point -- perhaps more - - from this less than rosy outlook. Similarly, should the nuclear crisis keep Japanese manufacturing shut down for more than a month, US GDP could be slashed as much as another one half a point—to something in the range of 2.5%.

Also, the festering European sovereign debt crisis and new weakness in the housing market threaten to further dampen exports and domestic consumption, and slow growth further.

Wrap all those together and a perfect storm may be brewing.

Growth below 2.5% would result in waves of new layoffs, a further tumble in housing prices, retreat in the equities market, and rising interest rates as the federal deficit soared. That combination would kill the recovery and send the economy into a second recession from which it might not recover for many years.

Structural Impediments to Growth

The US economy and the durability of American prosperity are too vulnerable, because temporary tax cuts, stimulus spending and large federal deficits do not address structural problems holding back GDP growth and jobs creation - - the huge trade deficit, dysfunctional energy and tax policies, and rising health care costs are the culprits.

At 3.3% of GDP, the $500bn trade deficit is a tax on domestic demand that erases the benefits of tax cuts. Consequently, the US economy is expanding at about 3% a year instead of the 5% pace that is possible after emerging from a deep recession and with such high unemployment.

Oil and trade with China account for nearly the entire US trade deficit.

The Administration is banking on electric cars and alternative technologies, such as wind and solar, to replace imported oil but those won’t pull down gasoline consumption enough to significantly reduce the oil import bill for a least a decade. Failure to produce more domestic oil and gas, by sending dollars abroad that do not sufficiently return to purchase US exports, is a jobs killer.

China maintains an undervalued currency by spending 10% of GDP to purchase dollars - - this reduces domestic Chinese consumption and subsidizes Chinese exports by about 35%. Failure act to offset Chinese currency subsidies, for example by taxing dollar yuan conversions, is the single most significant flaw in Administration policy to create an adequate numbers of jobs.

More broadly, major trading partners in Europe and Asia rely on value added taxes to finance government and health care, whereas Americans pay higher corporate taxes and directly for health care. Under WTO (World Trade Organization) rules, VATs (Value Added Tax)are rebateable on exports from Europe and Asia and are applied on imports from the United States into those markets, creating huge pricing disadvantages -- American products are essentially taxed twice. A neutral change in US tax policy toward a VAT - - swapping a VAT for reductions in corporate and personal income taxes—would help remove a major competitive disadvantage on US exporting and import-competing industries.

Finally, the 2010 health care law is pushing up health care costs, rather than reducing those as promised, making insurance unaffordable for many small and medium sized businesses. Although manufacturing has enjoyed a stronger recovery than the rest of the economy, it has been significantly focused on activities that use very little labor illustrating the burden that health care imposes on US employers.

Without fixing energy policies, addressing Chinese currency subsidies, modifying the tax structure, and truly reforming health care, high unemployment will be a permanent feature on the US economy and real wages will decline. Neither the Obama Administration nor Republican leadership in the Congress appears inclined to do what needs to be done.

Peter Morici, professor at Robert H. Smith School of Business, University of Maryland, explains why the US economy may be vulnerable to another recession:

A look at why many big investors are betting on America, in spite of the threat of higher interest rates from the Fed, with CNBC's Steve Liesman and Russell Goldsmith, City National Bank Chairman/CEO:

Peter Morici,

Professor, Robert H. Smith School of Business, University of Maryland,

College Park, MD 20742-1815,

703 549 4338 Phone

703 618 4338 Cell Phone




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