The House and the Senate have drafted a compromise stimulus bill totalling $789.5B, all but guaranteeing the largest economic rescue program since Roosevelt’s New Deal. Obama hailed the “endeavor of enormous scope and scale,” though it may turn out to be just a down payment on efforts to turn around the economy. The package, which exceeds the cost of the entire Iraq war since the 2003 invasion, will expand unemployment insurance, streamline health-care delivery, give Washington more control over local education spending and tilt federal assistance to the poor. Around 35% of the package is earmarked for tax cuts. Obama and Democratic leaders lowered their expectations for job creation to 3.5M from 4M. Both chambers could approve the compromise bill by the end of the week.
CNN-Money has a cool interactive map showing economic indicators for the 50 states. It demonstrates some of the points I have made in earlier posts about the recessionary effects not being felt equally across the country.
Some selected excerpts from the Time Magazine Cover Story “Why We’re So Gloomy”:
“I haven’t really been able to sort out exactly why there has been this degree of pessimism.”
~Former President Bush
Well, why are Americans so gloomy, fearful and even panicked about the current economic slump?
In one of history’s most painful paradoxes, U.S. consumers seem suddenly disillusioned with the American Dream of rising prosperity even as capitalism and democracy have consigned the Soviet Union to history’s trash heap. Hard times are forcing some people to turn their back on the American Dream.
“Whining” hardly captures the extent of the gloom Americans feel as the current downturn enters its 14th month. The slump is the longest, if not the deepest, since the Great Depression. Traumatized by layoffs that have cost more than 1.2 million jobs during the slump, U.S. consumers have fallen into their deepest funk in years.
While some economists have described the current slump as a near depression, that phrase overstates the case if it is taken as a comparison with the period 1929-33, when the U.S. economy contracted by nearly a third. The D word becomes more valid, especially with a small d, when it is used to compare the growth rate of the 1930s, which averaged 0.5% a year, with the expected sluggishness of the next decade, which some economists predict will see an average growth rate of 2%.
“I’m worried if my kids can earn a decent living and buy a house,” says Tony Lentini, vice president of public affairs for Mitchell Energy in Houston. “I wonder if this will be the first generation that didn’t do better than their parents. There’s a genuine feeling that the country has gotten way off track, and neither political party has any answers. Americans don’t see any solutions.”
The deeper tremors emanate from the kind of change that occurs only once every few decades. America is going through a historic transition from a heedless borrow-and-spend society to one that stresses savings and investment. When this recession is over, America will not simply go back to business as usual.
The underlying change in the way American consumers and business leaders think about saving and spending will make the recovery one of the slowest in history and the next decade one of lowered expectations. Many economists agree that the U.S. will face at least several years of very modest growth as consumers and companies work off the vast debt they assumed in the last decade.
The conditions that led to today’s transition economy go back several decades. Americans have suffered a long-term stagnation of their earnings. The median income of U.S. families has virtually stood still since 1973, showing an annual gain of just 0.3% a year.
The recent debt binge took place on a colossal scale in every sector of the economy. Runaway federal deficits have more than tripled the national debt. Meanwhile, consumers increased their IOUs from $1.4 trillion to $3.7 trillion last year. And U.S. industry raised its debt from $1.4 trillion to $3.5 trillion over the same period. The reckless borrowing made a reckoning inevitable.
So far, though, no reprieve from layoffs is anywhere in sight. Economists say U.S. companies will shed more than 1 million jobs in fields ranging from banking to aerospace, a pace even faster than last year’s. “It’s become almost like a poker game to see who can cut the most,” says employment analyst Lacey. “There’s a kind of corporate frenzy.”
GM’s plans to close 25 plants and cut 74,000 jobs, or 19% of its work force, scarcely addresses such problems as why it takes the company up to a year longer than the Japanese to redesign its cars.
This was from the January 13, 1992 edition of Time Magazine, and the opening quote was from President George H.W. Bush, and the article was about the relatively mild 1990-1991 recession. Note: The text above was altered slightly so that the specific time period was not obvious. Notice the distinct similarities to the reporting about today’s economy.
The July 1990 to March 1991 recession was one of the shortest in U.S. history (8 months according to the NBER) and relatively mild: the jobless rate averaged only 6.1% during the recession and reached a high of only 6.8% by the end of the recession (although it continued to rise after the recession ended, see chart above). I think there is a general consensus that the 1990-1991 was nowhere near as severe as the three previous recessions of the 1970s and 1980s, and it’s a fact that the 1973-1975 and 1981-1982 recessions were twice as long (16 months) as the 1990-1991 recession. And yet, to continue making the point, here is what the media were reporting about the 1990-1991 recession:
“In 1991 the average American expressed more pessimism about the future than at any time since the Great Depression.”
“There is no question but this is the worst economic time since the Great Depression.”
“Sluggish economic growth this year will cap the worst three-year period centered on a recession since the Great Depression.”
“Forecasts for a weak recovery in 1992 suggest the period since 1990 will be the worst for the economy since the Great Depression.”
“…..the worst plunge since the Great Depression.”
“The banking industry has plunged to its lowest point since the Great Depression.”
“This is the most severe economic dislocation we’ve had since the 1930s. Few are immune.”
“Mr. Barry, a past president of the Chamber of Commerce, said 50 For Sale signs are just the tip of the iceberg, since many bank foreclosures and repossessions do not carry signs. “It’s not a recession, it’s a depression,” he said.”
“….with the US economy locked in a recession and more people out of work since the Great Depression.”
“….the worst (retail) sales period on record since the Great Depression.”
“This recession is hitting white-collar workers more heavily than any since the Great Depression of the 1930s.”
Again, sound familiar? Links available here.
HT: Alex Tabarrok at Marginal Revolution and Mark Perry at Ca
Much attention has been placed in the media regarding President-elect Obama’s stimulus plan. The question of debate basically comes down to whether or not it is needed and, if so, what form of stimulus will work best?
Three criteria are crucial for evaluating fiscal stimulus packages. First, does the program target the weakness in the economy that caused the recession, or is it largely peripheral? Second, are the funds going to be spent in a timely fashion? Third, does the program fundamentally strengthen the economy going forward into the expansion phase? A look at the economy’s current circumstances suggests that a large fiscal stimulus is needed, but a badly designed one will, in the words of an old song, merely leave America “another day older and deeper in debt.”
The cause of the current recession is buried in the balance sheet of the private sector, particularly the financial sector and the household sector. The government and the Federal Reserve have begun a number of programs to fix the balance sheet of the financial sector, some more effective than others.
The main challenge facing the new administration and Congress is how to handle the inevitable efforts of Americans to fight the effects of the financial crisis by saving. It would be foolish to stop this adjustment with government policy both because any efforts to do so would fail and because the restoration of a healthier household balance sheet is essential to the long-term recovery of the economy. Instead, the government must focus on how to ameliorate the effects that the resulting reduction in household spending will have on the economy.
The household saving rate is likely to rise by roughly 7 percentage points, from roughly one-half of one percent of disposable income to between 7 and 8 percent. The majority of this adjustment is likely to occur well before the end of 2009, with some further modest increase thereafter. One estimate suggests a drop in consumer demand of roughly $500 billion in 2009 and a further drop of roughly half that figure in 2010. These frame the quantitative parameters for an appropriate fiscal stimulus.
The bulk of government spending programs that have been suggested involve transfers of federal resources to state and local governments. While any or all of these programs might qualify as meritorious in their own right, they collectively fail the tests of well targeted stimulus.
Note first that such spending programs do not directly address the household balance sheet problem. The history of such programs overwhelmingly suggests that states and localities will simply substitute federal funds for their own resources for the vast bulk of the money spent. As such, little net impact will be had on household balance sheets.
These programs also generally fail the test of timeliness. Consider the phrase “shovel ready” being used to describe many of these programs. By definition a shovel-ready project is one that state or local government has already spent a good deal of money developing and is likely to continue spending on. On the other hand, infrastructure projects that actually will produce net new spending are never shovel-ready. Most of the spending will end up occurring at the peak of the business cycle when it is not needed, not at the bottom.
By contrast, there are some ongoing federal spending programs that can be quickly ramped up during a recession. Most notable is defense procurement. There is wide agreement that we have run down our defense infrastructure substantially. Much of this can be remedied by simply increasing the pace of existing production programs. Think of it as “assembly line-ready” instead of shovel-ready. Defense spending also gets around the problem of federal dollars supplanting other spending, as only the federal government is involved.
The third test involves whether projects assist the economy in entering the expansion phase. In general, government spending programs divert resources from the private sector as it tries to expand. Some infrastructure projects genuinely assist the private sector by making it more efficient. One such project now being discussed is the creation of a national energy grid. This has been tried before, but failed to get through the legal roadblocks thrown in its path by environmental groups and private landowners. Thus, a project may be highly desirable, but not timely. It may be a good idea, but it is not stimulus.
The question to ask about any infrastructure project being sold as “stimulus” is why the project hasn’t been done already. The most common answer is that the state and local political process didn’t find that the benefits met the costs–a sure sign that the project is not likely to pay for itself during the expansion phase of the business cycle. Another test of the genuineness of the stimulus intent is whether the federal political process is willing to let go of its own political interests in an effort to maximize the stimulus effect. For example, will Congress waive the requirements that drive up costs and reduce the job creating benefits of infrastructure spending? Will they abandon earmarks alltogether? Not likely, IMHO.
The final argument made for federal funding of infrastructure spending by states is that it is needed to prevent or offset cuts that states will have to make in a weak economy. This argument essentially concedes the points made above, that such spending is really just a safety net for the public sector. It is at best job preserving, not job creating.
Permanent tax cuts offer a much better option. The incoming chairman of the Council of Economic Advisers, Christina Romer, has estimated that the macroeconomic benefits of tax cuts can be two to three times larger than common estimates of the benefits related to spending increases. The relative advantage of tax cuts over spending is even clearer when the recession is centered on the household balance sheet. Some relatively minor changes, like making the current 15 percent tax rate on dividends and capital gains permanent, would not only help household cash flow, but also put a floor under equity prices much as their introduction did in 2003. This would help protect against further wealth destruction and balance sheet deterioration.
But the centerpiece of any tax cut should be employment taxes: in particular, a permanent halving of the current 12.4 percent Social Security payroll tax on the first $106,800 of wages, split evenly between workers and employers. The direct revenue effect of that would be a bit under $400 billion per year, roughly in line with the present quantitative needs of the economy.
It also meets our three tests of effective stimulus. First, the funds would flow directly to households through higher take-home pay and indirectly through a reduction in the cost of employment. Economic studies conclude that the benefits of a reduction in the employer portion of the payroll tax are ultimately received by employees. But the immediate effect would be an improvement in the cash flow of credit-starved businesses (as well as being a marginal incentive to keep employment up).
Second, the funds would be extremely timely; with the benefits hitting the economy with the first paycheck after the plan was implemented. Third, by lowering the taxation of labor, the plan would help produce a higher-employment recovery than would otherwise be the case.
HT: Larry Lindsey
Recessions affect consumer spending unevenly. In most categories, individuals reduce their spending, but in a few categories they actually increase it. A recent McKinsey analysis of consumer spending during the 1990-91 and 2001-02 downturns shows that during these periods U.S. consumers spent less on amenities such as restaurant meals, personal-care products and services, apparel, and entertainment. But they spent more on groceries and reading materials — both of which substituted for more expensive options — as well as on less discretionary items like insurance and health care. Spending on education showed the biggest increase.
This short piece is from the “Industry Buzz” section of Lawn & Landscape’s December issue. A little longer than normal posts but worth it!
If you’re a small business owner, your list of worries seems never-ending. For starters, consumer confidence is down and your sales are starting to reflect that reality. And as experts predict a deep recession, it’s doubtful things will start looking up anytime soon. Yes, you’ve been wringing your hands and obsessing over the financial news for months, while simultaneously scrambling to keep your customers happy and your business strong. But action is the best antidote for agonizing, says Ed Hess—and now is the perfect time to create a recession contingency plan that will help you guide your business through any future rough patches.
“Too often, when the economy goes south, a small business owner is paralyzed by anxiety and isn’t able to act quickly enough to save his or her company,” says Hess, Professor of Business Administration and Batten Executive-in-Residence at the Darden School of Business at the University of Virginia and coauthor (with Charles Goetz) of So, You Want to Start a Business? 8 Steps to Take Before Making the Leap. “Having a well conceived contingency plan in place gives you peace of mind when trouble hits and enables you to act quickly.”
For small business owners, Hess says, contingency planning is one of the best and most effective preventive actions you can take in a down economy. “Contingency planning will allow you to make the best possible decisions for your business if things continue to get worse before they get better,” says Hess. “Even if you are an eternal optimist—after all, many of us entrepreneurs are—you’ll be wise to have a contingency plan in place if, say, one of your biggest clients succumbs to the bad economy, or if you have to face the difficult decision of whether or not to lay off an employee.”
If you’re unsure where to start when it comes to crafting your contingency plan, Hess explains the critical elements you’ll want to include:
A People Plan. For small business owners, employees are often like family. That means the most difficult decisions you’ll have to make will probably pertain to them. That said, it’s important that you remain objective when creating the “People” section of your contingency plan:
- What people assets are critical for you to keep? Why?
- Who can “afford” a salary cut?
- Who could undertake more responsibility?
- Who are your definite keepers?
- If you had to cut 10 percent of your workforce, what would your severance policy be?
- How would you treat departing people so as to engender trust, respect, and loyalty of those remaining?
- How would you implement a people “cut”?
“By answering these questions truthfully and thoroughly, it will be much easier for you to make decisions concerning what to do with your workforce during the slow economy,” says Hess. “Sometimes cutting back on your workforce, at least temporarily, is a necessary evil. Knowing that when you do so you are simply following a plan will help you manage some of the guilt that will come if you have to let someone go or reduce employee pay.”
A Key Customer Plan. It’s likely that your customers are feeling just as much anxiety as you are right now, so it’s best to handle them with kid gloves. Fail to do so and you risk damaging a relationship that will not only help get you through these hard times but which could prove very profitable when things pick back up. Here are a few things to consider when developing the customer section of your contingency plan:
- Who are your most profitable customers?
- Who are the most loyal?
- Who must you keep long-term at all costs?
- How is the downturn affecting each of your customers?
- How can you get closer to them?
- Which customers have pressures of their own that will force them to ask you to cut prices? And how should you respond? Should you extend credit, put them on an agreed-upon payment plan, etc.?
- What can you do to attract new customers?
“You and your customers are in the same boat,” says Hess. “They face the same struggles as you. In your dealings with them, it’s important that you strike a safe balance between managing their best interests and managing your own. The contingency plan will help you do that and help you make decisions that will allow you to strengthen your customer relationships now. When things pick back up, your customers will remember the way you treated them and will want to do even more business with you.”
A Cost-Cutting Plan. When deciding where you could cut expenses, it’s important to consider what you could do to cut costs immediately by 10-15 percent. You should also go through your expenses line by line and consider which expenses are not necessary for your survival. Be sure to involve your employees when creating this section of the plan. Because they are on the front lines every day, they may have a better idea of what can be cut. For example, maybe they’ve noticed that you have an incoming paper supply that could be reduced. You should also include in your plan what to do if the amount you pay to lease office or warehouse space becomes unmanageable.
“Naturally the decision to cut certain expenses will be easier to make than others,” says Hess. “Just remember that now is the time to get back to the basics. You don’t need lots of bells and whistles to run a successful business, and taking a look at your expenses will help you separate the necessities from the frills.”
A Cash Flow Plan. Cash flow is key to running any small business, and managing yours is never more important than in a tough economic period. That’s why you should include cash flow management in your contingency plan. There are two specific groups to consider: your customers and your vendors. First, think about how you can get delinquent customers to pay up. Talk with your customers and help them set up a payment plan with you so that you know you will be getting paid when you need it most. Also, consider giving a discount to those customers who agree to pay in cash. You should also think about how you can defer your cash outflows such as payments to vendors. Ask if you can go to a 60- or 90-day payment cycle.
“Keeping up a healthy cash flow is vital during a slow economy,” says Hess. “You might have to have tough conversations with customers who need to pay up or a vendor who you’d like to defer a payment to, but if these conversations help you keep cash in your business when you need it most, they will be worth it.”
A Financial Safety Net Plan. So what do you do when all of your customers have paid up and you’ve extended your payments to vendors, and you are still having cash flow problems? Quite simply, you consider more drastic ways of putting cash into your business. It’s time to fall back on the financial safety net that you’ve created for your company. What will your safety net be? Will you draw on your home equity? Stop taking a salary? Ask friends or family for a cash infusion? Sell off some of the company’s assets? Reduce employee salaries? Apply for a small business loan?
“You don’t want to be making these decisions when you are already in desperate need of cash,” says Hess. “While you are still in good shape, plan out the first three ways you could immediately increase your cash flow. And do everything to ensure that you are protecting your credit so that if you do need a small business loan you can get o
ne. Make certain to pay your bills on time. Don’t let anything fall through the cracks. If you are having trouble making a payment, let the company or bank know why. If there is a dispute on a payment, get something in writing that says you aren’t to blame. Being turned in to a collection agency will tank your credit score. You absolutely can’t risk it.”
An Exit Plan. There are some situations you simply can’t plan for. You can’t know for sure how your industry will be affected by the down economy. It’s possible that no matter what you do the slow economy will make it too difficult for you to keep your doors open or too difficult for you to navigate on your own.
“The exit plan is the hardest for any small business owner to put together,” says Hess. “No entrepreneur wants to give up on a venture, but sometimes you have to face reality. So, think about what lengths you are willing to go to in order to keep your doors open. If you are open to taking on a partner, what kind of person is going to add the necessary skills to the business to help you keep the doors open? Or if you decide to sell the business, would you want to stay on and keep working for the company or would you want to go your separate ways?
“Of course, keep in mind how long these transitions will take to make,” he adds. “As a small business owner you naturally have a strong attachment to your business. When you put so much blood, sweat, and tears into your business, it can be difficult to pull the plug at the right time. If you decide what your exit strategy will be before you are experiencing serious problems, you can take your emotions out of the decision-making process and come up with a clear-headed solution that protects your best interests.”
Creating a contingency plan will help you minimize the risk of any surprises that pop up—and they will!—during a slow economy. But keep in mind there are some basic things that you absolutely can’t lose focus on during a recession.
“You should be aggressively going after new customers, marketing your business nonstop, and giving your customers world-class service,” says Hess. “Yes, these are trying times for small business owners, but the obstacles are not insurmountable. With the right plan in place, you can create strong, long-lasting relationships with your customers and a business that can weather any storm.”
About the Authors:
Ed Hess lives in Charlottesville, Va., and spent most of his business life advising entrepreneurs and financing their business ventures. His professional career was spent with firms like Atlantic Richfield Company, Warburg Paribus Becker, Boettcher and Company, The Robert M. Bass Group, and Andersen Corporate Finance, and he has built three service businesses. In 2007, Hess joined the Faculty of the Darden School of Business at the University of Virginia as a Professor of Business Administration and Batten Executive-in-Residence where he teaches courses on building small businesses and organic growth.
Charlie Goetz earned his college degree at Emory University and holds an MBA from the University of Texas. He built several successful businesses, which in total employed over 1,500 people. He sold most of his businesses and made substantial amounts of money their sales. Goetz then began teaching entrepreneurship at Emory University in the Goizueta Business School. He lives in Atlanta, Ga., and is an investor in several new businesses and consults with people starting businesses.
The economist Joseph Schumpeter popularized and used the term creative destruction to describe the process of transformation that accompanies radical innovation. In Schumpeter’s vision of capitalism, innovative entry by entrepreneurs was the force that sustained long-term economic growth, even as it destroyed the value of established companies that enjoyed some degree of monopoly power (Wikipedia).
More than 500 American automobile manufacturers failed over the last 100 years for one reason or another, or were acquired, primarily due to the Schumpeterian forces of “creative destruction.” As far I know, not a single one of those auto manufacturers asked for, or was granted, government assistance, or received a government (aka taxpayer) bailout. Should there now be an exception for GM, Ford or Chrysler to get bailed out when none of the 548 defunct companies received assistance?
Trucking firms are downsizing rapidly. More than 130,000 big rigs (over 7%) have been pulled off the road already, and the figure will keep growing as the recession takes a toll. Many trucking firms will be forced out of business entirely and that will generate a huge shortage when the economy recovers. Demand will ramp up faster than capacity, so rates for moving freight will spike. Figure on paying about 10% more when the economic recovery is in full swing. Consider locking in a rate now. Offer to guarantee a minimum level of business in exchange for guaranteed service and limited price hikes.
According to the BLS report yesterday, the latest job market numbers show a recession that’s deepening. A total of 1.9 million jobs have been lost so far this year, with two-thirds of that in the past three months.
The Labor Department’s jobs data showed that the economy shed 533,000 jobs in November, the worst one month decline since December 1974 (though the number in 1974 represented a greater percentage of total workers, so the impact isn’t directly comparable). However, the composition of the declines was very different in the two periods. In December 1974, the drop in employment was almost two-thirds concentrated in the manufacturing sector, and less than a quarter in the services industry. The economy has changed drastically since then. Last month’s decline was less than a sixth in manufacturing, and more than two-thirds in services.
A loss this year of about 2.3 million looks likely, and losses in 2009 could total 3 million. The unemployment rate, which rose in November to 6.7% from 6.5% the previous month, is headed close to 9% in 2009. The losses are widespread, with gains only in education, health care and government.
As layoffs increase, incomes shrink and so does consumer spending, inducing firms to continue cutting payrolls. Making conditions worse are tighter lending standards by banks that hurt companies and their customers. While the rising unemployment rate is disturbing, it’s still nearly four percentage points below the 10.8% peak hit at the end of the 1981-82 recession.
Expect the economy to possibly show some signs of improvement by summer of 2009, but remember that job losses typically continue for a while after a recession ends.