The Book of Jobs

By Joseph E. Stiglitz

25 December 2011 

Vanity Fair January 2012

http://www.vanityfair.com/politics/2012/01/stiglitz-depression-201201

It has now been almost five years since the bursting of
the housing bubble, and four years since the onset of
the recession. There are 6.6 million fewer jobs in the
United States than there were four years ago. Some 23
million Americans who would like to work full-time
cannot get a job. Almost half of those who are
unemployed have been unemployed long-term. Wages are
falling-the real income of a typical American household
is now below the level it was in 1997.

We knew the crisis was serious back in 2008. And we
thought we knew who the "bad guys" were-the nation's
big banks, which through cynical lending and reckless
gambling had brought the U.S. to the brink of ruin. The
Bush and Obama administrations justified a bailout on
the grounds that only if the banks were handed money
without limit-and without conditions-could the economy
recover. We did this not because we loved the banks but
because (we were told) we couldn't do without the
lending that they made possible. Many, especially in
the financial sector, argued that strong, resolute, and
generous action to save not just the banks but the
bankers, their shareholders, and their creditors would
return the economy to where it had been before the
crisis. In the meantime, a short-term stimulus,
moderate in size, would suffice to tide the economy
over until the banks could be restored to health.

The banks got their bailout. Some of the money went to
bonuses. Little of it went to lending. And the economy
didn't really recover-output is barely greater than it
was before the crisis, and the job situation is bleak.
The diagnosis of our condition and the prescription
that followed from it were incorrect. First, it was
wrong to think that the bankers would mend their
ways-that they would start to lend, if only they were
treated nicely enough. We were told, in effect: "Don't
put conditions on the banks to require them to
restructure the mortgages or to behave more honestly in
their foreclosures. Don't force them to use the money
to lend. Such conditions will upset our delicate
markets." In the end, bank managers looked out for
themselves and did what they are accustomed to doing.

Even when we fully repair the banking system, we'll
still be in deep trouble-because we were already in
deep trouble. That seeming golden age of 2007 was far
from a paradise. Yes, America had many things about
which it could be proud. Companies in the
information-technology field were at the leading edge
of a revolution. But incomes for most working Americans
still hadn't returned to their levels prior to the
previous recession. The American standard of living was
sustained only by rising debt-debt so large that the
U.S. savings rate had dropped to near zero. And "zero"
doesn't really tell the story. Because the rich have
always been able to save a significant percentage of
their income, putting them in the positive column, an
average rate of close to zero means that everyone else
must be in negative numbers. (Here's the reality: in
the years leading up to the recession, according to
research done by my Columbia University colleague Bruce
Greenwald, the bottom 80 percent of the American
population had been spending around 110 percent of its
income.) What made this level of indebtedness possible
was the housing bubble, which Alan Greenspan and then
Ben Bernanke, chairmen of the Federal Reserve Board,
helped to engineer through low interest rates and
nonregulation-not even using the regulatory tools they
had. As we now know, this enabled banks to lend and
households to borrow on the basis of assets whose value
was determined in part by mass delusion.

The fact is the economy in the years before the current
crisis was fundamentally weak, with the bubble, and the
unsustainable consumption to which it gave rise, acting
as life support. Without these, unemployment would have
been high. It was absurd to think that fixing the
banking system could by itself restore the economy to
health. Bringing the economy back to "where it was"
does nothing to address the underlying problems.

The trauma we're experiencing right now resembles the
trauma we experienced 80 years ago, during the Great
Depression, and it has been brought on by an analogous
set of circumstances. Then, as now, we faced a
breakdown of the banking system. But then, as now, the
breakdown of the banking system was in part a
consequence of deeper problems. Even if we correctly
respond to the trauma-the failures of the financial
sector-it will take a decade or more to achieve full
recovery. Under the best of conditions, we will endure
a Long Slump. If we respond incorrectly, as we have
been, the Long Slump will last even longer, and the
parallel with the Depression will take on a tragic new
dimension.

Until now, the Depression was the last time in American
history that unemployment exceeded 8 percent four years
after the onset of recession. And never in the last 60
years has economic output been barely greater, four
years after a recession, than it was before the
recession started. The percentage of the civilian
population at work has fallen by twice as much as in
any post-World War II downturn. Not surprisingly,
economists have begun to reflect on the similarities
and differences between our Long Slump and the Great
Depression. Extracting the right lessons is not easy.

Many have argued that the Depression was caused
primarily by excessive tightening of the money supply
on the part of the Federal Reserve Board. Ben Bernanke,
a scholar of the Depression, has stated publicly that
this was the lesson he took away, and the reason he
opened the monetary spigots. He opened them very wide.
Beginning in 2008, the balance sheet of the Fed doubled
and then rose to three times its earlier level. Today
it is $2.8 trillion. While the Fed, by doing this, may
have succeeded in saving the banks, it didn't succeed
in saving the economy.

Reality has not only discredited the Fed but also
raised questions about one of the conventional
interpretations of the origins of the Depression. The
argument has been made that the Fed caused the
Depression by tightening money, and if only the Fed
back then had increased the money supply-in other
words, had done what the Fed has done today-a
full-blown Depression would likely have been averted.
In economics, it's difficult to test hypotheses with
controlled experiments of the kind the hard sciences
can conduct. But the inability of the monetary
expansion to counteract this current recession should
forever lay to rest the idea that monetary policy was
the prime culprit in the 1930s. The problem today, as
it was then, is something else. The problem today is
the so-called real economy. It's a problem rooted in
the kinds of jobs we have, the kind we need, and the
kind we're losing, and rooted as well in the kind of
workers we want and the kind we don't know what to do
with. The real economy has been in a state of wrenching
transition for decades, and its dislocations have never
been squarely faced. A crisis of the real economy lies
behind the Long Slump, just as it lay behind the Great
Depression.

For the past several years, Bruce Greenwald and I have
been engaged in research on an alternative theory of
the Depression-and an alternative analysis of what is
ailing the economy today. This explanation sees the
financial crisis of the 1930s as a consequence not so
much of a financial implosion but of the economy's
underlying weakness. The breakdown of the banking
system didn't culminate until 1933, long after the
Depression began and long after unemployment had
started to soar. By 1931 unemployment was already
around 16 percent, and it reached 23 percent in 1932.
Shantytown "Hoovervilles" were springing up everywhere.
The underlying cause was a structural change in the
real economy: the widespread decline in agricultural
prices and incomes, caused by what is ordinarily a
"good thing"-greater productivity.

At the beginning of the Depression, more than a fifth
of all Americans worked on farms. Between 1929 and
1932, these people saw their incomes cut by somewhere
between one-third and two-thirds, compounding problems
that farmers had faced for years. Agriculture had been
a victim of its own success. In 1900, it took a large
portion of the U.S. population to produce enough food
for the country as a whole. Then came a revolution in
agriculture that would gain pace throughout the
century-better seeds, better fertilizer, better farming
practices, along with widespread mechanization. Today,
2 percent of Americans produce more food than we can
consume.

What this transition meant, however, is that jobs and
livelihoods on the farm were being destroyed. Because
of accelerating productivity, output was increasing
faster than demand, and prices fell sharply. It was
this, more than anything else, that led to rapidly
declining incomes. Farmers then (like workers now)
borrowed heavily to sustain living standards and
production. Because neither the farmers nor their
bankers anticipated the steepness of the price
declines, a credit crunch quickly ensued. Farmers
simply couldn't pay back what they owed. The financial
sector was swept into the vortex of declining farm
incomes.

The cities weren't spared-far from it. As rural incomes
fell, farmers had less and less money to buy goods
produced in factories. Manufacturers had to lay off
workers, which further diminished demand for
agricultural produce, driving down prices even more.
Before long, this vicious circle affected the entire
national economy.

The value of assets (such as homes) often declines when
incomes do. Farmers got trapped in their declining
sector and in their depressed locales. Diminished
income and wealth made migration to the cities more
difficult; high urban unemployment made migration less
attractive. Throughout the 1930s, in spite of the
massive drop in farm income, there was little overall
out-migration. Meanwhile, the farmers continued to
produce, sometimes working even harder to make up for
lower prices. Individually, that made sense;
collectively, it didn't, as any increased output kept
forcing prices down.

Given the magnitude of the decline in farm income, it's
no wonder that the New Deal itself could not bring the
country out of crisis. The programs were too small, and
many were soon abandoned. By 1937, F.D.R., giving way
to the deficit hawks, had cut back on stimulus
efforts-a disastrous error. Meanwhile, hard-pressed
states and localities were being forced to let
employees go, just as they are now. The banking crisis
undoubtedly compounded all these problems, and extended
and deepened the downturn. But any analysis of
financial disruption has to begin with what started off
the chain reaction.

The Agriculture Adjustment Act, F.D.R.'s farm program,
which was designed to raise prices by cutting back on
production, may have eased the situation somewhat, at
the margins. But it was not until government spending
soared in preparation for global war that America
started to emerge from the Depression. It is important
to grasp this simple truth: it was government
spending-a Keynesian stimulus, not any correction of
monetary policy or any revival of the banking
system-that brought about recovery. The long-run
prospects for the economy would, of course, have been
even better if more of the money had been spent on
investments in education, technology, and
infrastructure rather than munitions, but even so, the
strong public spending more than offset the weaknesses
in private spending.

Government spending unintentionally solved the
economy's underlying problem: it completed a necessary
structural transformation, moving America, and
especially the South, decisively from agriculture to
manufacturing. Americans tend to be allergic to terms
like "industrial policy," but that's what war spending
was-a policy that permanently changed the nature of the
economy. Massive job creation in the urban sector-in
manufacturing-succeeded in moving people out of
farming. The supply of food and the demand for it came
into balance again: farm prices started to rise. The
new migrants to the cities got training in urban life
and factory skills, and after the war the G.I. Bill
ensured that returning veterans would be equipped to
thrive in a modern industrial society. Meanwhile, the
vast pool of labor trapped on farms had all but
disappeared. The process had been long and very
painful, but the source of economic distress was gone.

The parallels between the story of the origin of the
Great Depression and that of our Long Slump are strong.
Back then we were moving from agriculture to
manufacturing. Today we are moving from manufacturing
to a service economy. The decline in manufacturing jobs
has been dramatic-from about a third of the workforce
60 years ago to less than a tenth of it today. The pace
has quickened markedly during the past decade. There
are two reasons for the decline. One is greater
productivity-the same dynamic that revolutionized
agriculture and forced a majority of American farmers
to look for work elsewhere. The other is globalization,
which has sent millions of jobs overseas, to low-wage
countries or those that have been investing more in
infrastructure or technology. (As Greenwald has pointed
out, most of the job loss in the 1990s was related to
productivity increases, not to globalization.) Whatever
the specific cause, the inevitable result is precisely
the same as it was 80 years ago: a decline in income
and jobs. The millions of jobless former factory
workers once employed in cities such as Youngstown and
Birmingham and Gary and Detroit are the modern-day
equivalent of the Depression's doomed farmers.

The consequences for consumer spending, and for the
fundamental health of the economy-not to mention the
appalling human cost-are obvious, though we were able
to ignore them for a while. For a time, the bubbles in
the housing and lending markets concealed the problem
by creating artificial demand, which in turn created
jobs in the financial sector and in construction and
elsewhere. The bubble even made workers forget that
their incomes were declining. They savored the
possibility of wealth beyond their dreams, as the value
of their houses soared and the value of their pensions,
invested in the stock market, seemed to be doing
likewise. But the jobs were temporary, fueled on vapor.

Mainstream macro-economists argue that the true
bogeyman in a downturn is not falling wages but rigid
wages-if only wages were more flexible (that is,
lower), downturns would correct themselves! But this
wasn't true during the Depression, and it isn't true
now. On the contrary, lower wages and incomes would
simply reduce demand, weakening the economy further.

Of four major service sectors-finance, real estate,
health, and education-the first two were bloated before
the current crisis set in. The other two, health and
education, have traditionally received heavy government
support. But government austerity at every level-that
is, the slashing of budgets in the face of
recession-has hit education especially hard, just as it
has decimated the government sector as a whole. Nearly
700,000 state- and local-government jobs have
disappeared during the past four years, mirroring what
happened in the Depression. As in 1937, deficit hawks
today call for balanced budgets and more and more
cutbacks. Instead of pushing forward a structural
transition that is inevitable-instead of investing in
the right kinds of human capital, technology, and
infrastructure, which will eventually pull us where we
need to be-the government is holding back. Current
strategies can have only one outcome: they will ensure
that the Long Slump will be longer and deeper than it
ever needed to be.

Two conclusions can be drawn from this brief history.
The first is that the economy will not bounce back on
its own, at least not in a time frame that matters to
ordinary people. Yes, all those foreclosed homes will
eventually find someone to live in them, or be torn
down. Prices will at some point stabilize and even
start to rise. Americans will also adjust to a lower
standard of living-not just living within their means
but living beneath their means as they struggle to pay
off a mountain of debt. But the damage will be
enormous. America's conception of itself as a land of
opportunity is already badly eroded. Unemployed young
people are alienated. It will be harder and harder to
get some large proportion of them onto a productive
track. They will be scarred for life by what is
happening today. Drive through the industrial river
valleys of the Midwest or the small towns of the Plains
or the factory hubs of the South, and you will see a
picture of irreversible decay.

Monetary policy is not going to help us out of this
mess. Ben Bernanke has, belatedly, admitted as much.
The Fed played an important role in creating the
current conditions-by encouraging the bubble that led
to unsustainable consumption-but there is now little it
can do to mitigate the consequences. I can understand
that its members may feel some degree of guilt. But
anyone who believes that monetary policy is going to
resuscitate the economy will be sorely disappointed.
That idea is a distraction, and a dangerous one.

What we need to do instead is embark on a massive
investment program-as we did, virtually by accident, 80
years ago-that will increase our productivity for years
to come, and will also increase employment now. This
public investment, and the resultant restoration in
G.D.P., increases the returns to private investment.
Public investments could be directed at improving the
quality of life and real productivity-unlike the
private-sector investments in financial innovations,
which turned out to be more akin to financial weapons
of mass destruction. Can we actually bring ourselves to
do this, in the absence of mobilization for global war?
Maybe not. The good news (in a sense) is that the
United States has under-invested in infrastructure,
technology, and education for decades, so the return on
additional investment is high, while the cost of
capital is at an unprecedented low. If we borrow today
to finance high-return investments, our debt-to-G.D.P.
ratio-the usual measure of debt sustainability-will be
markedly improved. If we simultaneously increased
taxes-for instance, on the top 1 percent of all
households, measured by income-our debt sustainability
would be improved even more.

The private sector by itself won't, and can't,
undertake structural transformation of the magnitude
needed-even if the Fed were to keep interest rates at
zero for years to come. The only way it will happen is
through a government stimulus designed not to preserve
the old economy but to focus instead on creating a new
one. We have to transition out of manufacturing and
into services that people want-into productive
activities that increase living standards, not those
that increase risk and inequality. To that end, there
are many high-return investments we can make. Education
is a crucial one-a highly educated population is a
fundamental driver of economic growth. Support is
needed for basic research. Government investment in
earlier decades-for instance, to develop the Internet
and biotechnology-helped fuel economic growth. Without
investment in basic research, what will fuel the next
spurt of innovation? Meanwhile, the states could
certainly use federal help in closing budget
shortfalls. Long-term economic growth at our current
rates of resource consumption is impossible, so funding
research, skilled technicians, and initiatives for
cleaner and more efficient energy production will not
only help us out of the recession but also build a
robust economy for decades. Finally, our decaying
infrastructure, from roads and railroads to levees and
power plants, is a prime target for profitable
investment.

The second conclusion is this: If we expect to maintain
any semblance of "normality," we must fix the financial
system. As noted, the implosion of the financial sector
may not have been the underlying cause of our current
crisis-but it has made it worse, and it's an obstacle
to long-term recovery. Small and medium-size companies,
especially new ones, are disproportionately the source
of job creation in any economy, and they have been
especially hard-hit. What's needed is to get banks out
of the dangerous business of speculating and back into
the boring business of lending. But we have not fixed
the financial system. Rather, we have poured money into
the banks, without restrictions, without conditions,
and without a vision of the kind of banking system we
want and need. We have, in a phrase, confused ends with
means. A banking system is supposed to serve society,
not the other way around.

That we should tolerate such a confusion of ends and
means says something deeply disturbing about where our
economy and our society have been heading. Americans in
general are coming to understand what has happened.
Protesters around the country, galvanized by the Occupy
Wall Street movement, already know.

___________________________________________

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