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We’re gonna need a bigger hand basket

By Jock O’Connell

This op-ed article appeared in the Sacramento Bee on Sunday, February 15, 2009 under the headline "Fiscal reality points to an austere future."

Cash-strapped officials in communities throughout California are anxiously cobbling together mid-year packages of spending cuts and revenue enhancements in hopes of keeping civic body and soul together until that $800 billion federal stimulus program jumpstarts a moribund economy.

The underlying presumption, regardless of locale, is that economic recovery will restore fiscal affairs to “normal” – a condition implicitly defined as where things were before the popping of a housing bubble down the road in Stockton in 2007 triggered, through a series of seemingly improbable steps, a cataclysm on Wall Street and then a worldwide recession. In the interim, it’s a matter of holding the fort until the cavalry arrives to save the day.

Alas, the expectation – really a collective prayer -- that public officials will be singing "Happy Days Are Here Again" either later this year or early next is not likely to be answered. Instead, state and local policymakers working with the accounting equivalent of spit and bailing wire to balance their budgets should start planning for an extended period of austerity in public finance.

Why the bearish outlook?

Let’s begin with the fact that consumer spending accounts for just over 70 percent of America’s gross domestic product, the broad measure of the value of all goods and services produced here in the United States. From 1997 through 2007, real (inflation-adjusted) GDP grew by 32.4 percent. It was paced by a 41.5 percent rise in real consumer expenditures, according to the Commerce Department.

What was remarkable about that impressive surge in consumer spending is that it occurred despite the fact that average household income had remained fairly stagnant over the same period. Indeed, according Census Bureau data, real household income in 2007 was actually slightly lower than it had been in 1999.

So how were we able to indulge in a decade-long shopping spree even though most of us were not seeing higher incomes? The short answer, of course, is that we borrowed and then borrowed some more. We refinanced home mortgages and spent the proceeds. And we exercised our credit cards, largely because we believed that our homes would continue to soar in value. It certainly wasn’t because the average paycheck was getting any bigger.

Harvard University’s Niall Ferguson estimates that, from 1997 through 2006, Americans withdrew some $9 trillion in cash from the equity stored up in our homes. At the same time, credit card debt spiked to unprecedented highs.

Then in flew the Black Swan to deliver a reality check. Starting in the summer of 2007, housing values began to plunge, the credit markets froze, stock prices tanked, and millions of Americans saw their retirement accounts shrink as their creditworthiness diminished.

What is left today is an economy that is acutely dependent on the spending of people who are now pretty much tapped out. Those vacuous pundits and editorial writers who see a restoration of consumer confidence as key to economic recovery simply fail to appreciate that a lack of optimism is not the problem. When nearly half of all American households live paycheck to paycheck, when millions of Americans owe more than their assets (chiefly their homes) are worth, and when unemployment is a common dread, it is silly to think that a torrent of consumer spending is there to be unleashed. Or that financial institutions will gleefully re-inflate the credit bubble merely to enable the penurious to be profligate once more.

So long as average household income remains stagnant, economic growth rates over the next several years are apt to remain modest. The rub is that most of the factors that have worked to suppress growth in real household income are still very much at play.

Not the least of these is the demonstrable reluctance of American consumers for pay higher prices for products made by American workers. (Just about the only large retailer to show gains over the Christmas holiday season was Wal-Mart, a retailer which by some estimates accounts for eight percent of all U.S. imports.) Under-employment remains a critical, chronic issue facing millions of Americans as business models encourage more companies to hire workers on a contingent basis, meaning more part-time labor without health and retirement benefits. On top of this, the nation’s 75 million baby-boomers are starting to retire.

Meanwhile, technological developments continue to substitute for labor. Off-shoring or at least the threat of moving production or service provision to another country remains a powerful bargaining tool in countering employee demands. Unions remain weak, and where growing they tend to be concentrated in representing low-wage workers in the service and entertainment sectors. And those sectors of the economy in which job creation is expected to be most robust are also the sectors in which wage levels have been relatively low.

Under the circumstances, public officials who hopefully look for revenue flows to soon return to the levels seen earlier in this decade are going to be gravely disappointed. While an $800 billion economic stimulus measure coming out of Washington should provide some relief in the near-term, it likely won’t have much impact on improving the financial condition of the average household. It therefore will not be the long-term fiscal panacea most state and local officials are praying for.

So it is time to put aside the smoke, mirrors, the furloughs and other “temporary” fixes and to begin a sobering debate over the government spending priorities voters are prepared to life with for several years to come.