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New Reality Is Leaving Growth in the Mire

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Jul 26, 2003, 12:50:56 AM7/26/03
Why this recession is unlike the previous one 12 years ago...
New Reality Is Leaving Growth in the Mire

"New Reality Is Leaving Growth in the Mire

FOR nearly 29 months, the nation has struggled through a recession
and a weak recovery. That is a long struggle, a new form of hardship
for many Americans, who are tantalized with incessant forecasts that a
decisive upturn is about to happen. But as the months wear on, the
dogged optimism detaches from reality.

For starters, the forecasters seem not to grasp how much the American
economy has deviated from the standard business cycle and the standard
cures. A major reason for the deviation is the mobility of American
companies, particularly the ease with which they now shift operations
to China and India. "The wholesale movement of jobs and production
overseas is handcuffing the recovery," said Mark M. Zandi, chief
economist at

In other downturns since World War II, the economy moved from healthy
growth to contraction and back to healthy growth, all in less than two
years. The downward swings were relatively easy to fix. The swings
began when companies found themselves producing more goods and
services than people bought. Inventories built up, particularly in
manufacturing, and companies responded by cutting output until it was
below demand. Rather than produce more, companies filled orders from
stockpiles. As output declined, unemployment rose and wages stopped
increasing. Capital spending also suffered. After all, why expand when
the capacity to produce already exceeds demand?

But the damage did not last long. The Federal Reserve stepped in,
cutting interest rates to encourage spending. Unemployment insurance,
public spending, and sometimes tax cuts, helped resurrect demand. As
spending picked up and inventories disappeared, prices began to rise,
which encouraged more production. Hiring resumed, as did capital

These various remedies are being used now, and there is some strength
in spending. Yet inventories have failed to diminish, so prices,
production, hiring and capital spending do not rise.

The difficulty is that companies have a choice that was not as
available in the last downturn 12 years ago. Rather than halt
production at home, they shift it abroad to cut costs, particularly
labor costs. They feel compelled to do this. If they did not, their
competitors would upstage them with their own lower-cost, overseas
production that takes away sales back home.

In the process, the mechanism for restoring our economy to healthy
growth by reducing inventories and excess capacity fails to function
properly. Inventories may seem to diminish when only "Made in America"
is counted. But in the new global economy, what's made in America and
what's made abroad both contribute to inventories and capacity. The
total does not shrink, and the economy flounders month after month.

Still, there is some relief. Super-low interest rates, mortgage
refinancing, stepped-up military spending and some of the Bush tax
cuts augur a temporary pop in economic growth. But temporary is the
operative word. The more enduring pressure on the economy is downward,
not upward.

THE biggest beneficiary appears to be China. Abundant transportation
has made China an ever-easier place for American companies to shift
production of goods and services for sale in the market back home.

The nation's trade deficit, the excess of our imports over exports,
has risen by 31 percent since the recession began in March 2001. The
increase, totaling $114 billion, would add one percentage point to
American economic growth enough to turn a weak recovery into a strong
one if the rise in output were at home, not abroad. One-third of the
total increase represents imports from China, Mr. Zandi says. Honing
the figures, Steven S. Roach, chief economist at Morgan Stanley, finds
that China's total exports have tripled since 1994, and that 65
percent of the $244 billion increase comes from foreign companies in

"We are criticizing the Chinese as if they were cleaning our clock and
the only part of China that is cleaning our clock is the part that we
put there," Mr. Roach said.

What is to be done? If we do anything, we are likely to pressure the
Chinese to float their currency. A floating yuan would rise against
the dollar, making Chinese exports more costly in the United States.
Pressure is already coming from Congress for the Bush administration
to negotiate the float.

We could also force American companies, through regulations, to stay
out of countries that fail to observe minimal labor and environmental
standards. Regulation is not popular in America. But it could regain
its popularity, if the alternative is a continual loss of jobs in
every state."

--Jerry Leslie (my opinions are strictly my own)
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