It's the Confidence, Stupid.

The economy grew by 3.1 percent in the second quarter. That's a respectable rate. The third quarter is off to a great start, with strong spending and production in July and August. Economists wouldn't be surprised if GDP growth for the quarter hits 5 percent.

Yet the job market remains bad. Today the Bureau of Labor Statistics reported that the number of payroll jobs fell by 93,000 in August, and is now down by 440,000 since the beginning of the year.

How can the economy grow rapidly while the employment market remains so grim?

The immediate explanation is high productivity growth. Labor productivity grew by a stunning 6.8 percent in the second quarter, and will probably grow almost as fast in the third.

But the real reason employment continues to lag is a lack of confidence in future economic growth.

Businesses know that short-term demand is being artificially pumped up by yet another round of tax cuts and a continuation of rapid growth in government spending. That is why our federal deficit is poised to hit $400 billion this year, and $500 billion in 2004.

Therefore, investors doubt the current surge will last. The government can't go on running massive deficits, and interest rates won't stay at rock bottom for much longer. (Long term interest rates are already on the rise.)

So we may have another good quarter or two, but the longer-run outlook remains mediocre.

As a result, businesses are squeezing as much productivity as possible out of current workers, but are not making bold new investments in either capital or hiring for the future.

Why do business lack confidence? Two reasons: (1) President Bush's economic strategy of massive deficits is unsound, and (2) the President's economic advisors are ineffectual.

Wall Street will always tout tax cuts for high-income investors. But savvy investors and business leaders know that President Bush's economic strategy of continuous tax cuts, with no perceptible spending restraint, will likely cause large, permanent deficits. With the baby boom generation poised to retire and explode entitlement spending, Bush's policy of massive deficits is fundamentally unsound.

Moreover, President Bush has assembled the weakest, most politicized economic team in memory. Officials who undercut the White House talking points are quickly dispatched. Former Treasury Secretary Paul O'Neill was fired for thinking independently of the political maestros. Former National Economic Council head Larry Lindsey -- perhaps the gloomiest economist around -- was fired for accurately estimating the cost of the Iraq war and reconstruction.

The President's Office of Management and Budget (OMB) has no credibility on Capitol Hill. That is because the Administration's official numbers are rife with gimmicks and omissions, and because the White House has never followed through on budget cuts (except in peevish political ways, like cutting President Clinton's Americorps national service program). On the bigger issues of agriculture subsidies, transportation funds, Medicare payments, and so on, the Administration and Congress have an unspoken pact to spend at will.

The Administration's two most capable economic officials -- academic Gregory Mankiw and Wall Street veteran Steven Friedman -- keep such a low profile we hardly know their names. The new Treasury Secretary dutifully reads his talking points, but has no credibility in financial markets.

At this point, economic strategy in the Bush Administration is run mostly by outside political organizations, like Grover Norquist's Americans for Tax Reform and Stephen Moore's Club for Growth, whose ideology amounts to "the government is evil."

Under that core principle, these organizations have lured the Bush Administration and much of the Republican party into embracing an economic policy that could be characterized as "strength through weakness." They encourage continuous tax cutting to create deficits of crisis proportions. Ultimately, they presume government spending (and influence) will be reduced. The long-range goal is to destroy the government at as many levels as possible.

However, those groups have done nothing to actually reduce spending -- presumably that will be someone else's problem in the future.

In the meantime, the U.S. is weakened to the point of pleading for help in Iraq from "old" Europe, and begging the Chinese to adjust their exchange rate.

The business community and Wall Street are mostly Republican, and loyal. They will not directly criticize the President's economic strategy or his advisors.

But they will not vote "yes" to this economy until President Bush chooses a healthier and less cynical economic strategy, and builds an economic team that inspires confidence, not trepidation.

With luck, jobs will start to come back later this year. But a vigorous, sustained recovery -- with large-scale job growth -- may remain elusive as long as businesses and investors lack faith in the nation's economic policies.

Links:
Centrists.Org No-BS Long-Term Budget Baseline homepage

Posted by Jeff Lemieux at September 5, 2003 11:55 AM