VIENNA, Jan. 11 (UPI) -- This time last year, many economists were still debating whether the United States was entering or already experiencing a recession. That debate is over. The question now is whether we are entering a depression and how great or modest it will be.
There is no formal definition for a depression. Like pornography, we know it when we see it. But some economists suggest that a 10 percent drop in GDP would qualify. We are not there yet, but the momentum is ugly, because this is now a global problem.
In Britain, national income fell by 1.5 percent in the fourth quarter of 2008 and industrial production fell by 2.7 percent in the three months to November. Germany reported industrial output fell by 3.1 percent in November compared with October, the third consecutive monthly fall. France reported a 2.4 percent drop in the month.
They were the lucky ones. Elsewhere in Europe, countries are already in depression territory. In Spain, production at factories and mines was 15.1 percent lower than a year before. Sweden reported an 11.9 percent year-on-year fall in industrial production. Worse still, orders dropped by 26.2 percent.
In the United States, 524,000 payroll jobs were lost in December, having lost 2.6 million jobs in the year. The conventional unemployment rate has risen to 7.2 percent, but includes workers who are now off the rolls and forced part-time work, and the true jobless rate is already in double digits, with the economy contracting at about 5 percent annual rate in the fourth quarter.
The prospects for the coming year are grim. The retail, construction and financial sectors are all in deep trouble that is probably getting deeper. This is mainly because the United States is going through a fundamental (and too long delayed) shift away from consumption and toward saving.
Between 1950 and 1983, personal consumption stayed within a range of 61 percent to 63 percent of GDP. In the past 25 years, it has risen to 71 percent of GDP and savings have shrunk to zero. We are now heading back to a sustainable level of consuming around 65 percent of GDP, and over the next two to three years this will shift about $1 trillion a year out of the retail economy and into debt reduction and savings.
This is probably necessary, but it will be painful for shops and restaurants, hotels and airlines, property developers and car manufacturers, the newspaper industry and advertising, to name but the most obvious victims.
Does this mean we are heading into a depression? Professor Peter Morici of the University of Maryland, formerly the chief economist for the U.S. trade representative and one of the best forecasters in the business, has an interesting definition of the difference between recession and depression.
Recessions, he maintains, are self-correcting, "like stock market corrections that eventually rebound without government intervention. Federal Reserve interest rate cuts and stimulus tax rebates and spending have shortened the lives and eased the impact of post-World War II recessions, but those policies did not end them. The economy self-corrected."
By contrast, he argues, "A depression is not self-correcting. Roosevelt administration stimulus packages -- huge deficit spending -- eased the pain but failed to end the Great Depression. Similarly, President-elect Obama's massive stimulus package, alone, won't fix the U.S. economy."
Morici identifies three structural problems of the current crisis that are not self-correcting and will require robust government intervention. The first is bad management practices at the large money center banks. The second is the huge foreign trade deficit, and the third is part of the second: the dependence on imported energy.
"The economy will not recover without fundamental changes in banking and trade policy," Morici believes. "A large stimulus package, though necessary, will only give the economy a temporary lift, but then unemployment will rise again and continue at unacceptable levels indefinitely without successively larger stimulus packages and huge federal budget deficits. The economy is in a depression, not a recession."
President-elect Barack Obama will find a great deal of support in reforming the banks and ensuring that they reward the federal government's loans and guarantees by renegotiating mortgages and making loans to creditworthy businesses.
It will be tougher to fix the trade deficit, particularly when putting more money into consumers' pockets through tax cuts is likely to result in more imports of cheap Chinese consumer goods. Morici, a longtime critic of China's manipulation of its currency to keep its exports competitive, wants tough measures against China.
"Fixing trade with China will require a tax on dollar-yuan transactions if China continues to refuse to stop subsidizing dollar purchases of yuan to prop up its exports and shift Chinese unemployment to the U.S. manufacturing sector," Morici claims.
Many economists fear this could start the kind of protectionist trade war that made the 1930s Depression so much worse by strangling world trade. And Morici's argument on the energy deficit is also likely to be controversial, although it makes eminent sense.
He thinks Obama should outrage the environmentalists by pushing for more oil and gas drilling in the United States in Alaska and offshore, and outrage the global warming skeptics by pushing big subsidies and investments in alternative energy and tough new fuel economy standards. Some economists go even further, advocating variable fuel taxes to impose a new floor of $2.50 or $3 a gallon on gas.
The details, while important, may be less critical than Morici's insight into the difference between the recession we entered last year and the depression that threatens us this year, and the need for fundamental structural reforms to tackle it.
