The Lehmann Letter ©
Thursday
November 15, 2007
Supply Side… Demand Side…
All economic expansions come to an end, and this one will, too. “This time, it’s different” was what they said just before the last (2001) recession.
In the 1960s the Commerce Department issued a monthly publication entitled Business Cycles Digest, or BCD for short. Its charts measured the ebb and flow of the business cycle, i.e. economic expansion and contraction, boom and bust, prosperity and recession. By the end of the 1960s the folks at the Commerce Department recalled that there hadn’t been a recession since 1960. Perhaps the government’s macroeconomic (fiscal and monetary) policies worked so well that they had tamed the business cycle. So the Commerce Department changed Business Cycles Digest to Business Conditions Digest (still BCD), to commemorate its conclusion that there would be no more recessions. Sure enough, the title change was just in time for the 1970 recession.
If all expansions end in contraction (and they do), will the next recession have the same cause as the last recession? Probably not, because the last recession was a supply-side phenomenon and the next one will most likely have demand-side origins.
The profit-margins chart will assist your understanding of the 2001 recession.
Profit Margins
In the 1990s New Economy advocates said. “This time it’s different…,” because they believed the Personal Computer revolution had dramatically altered supply-side conditions. Electronic communication and the web would boost business efficiency (e.g. no more purchase orders) by eliminating paper work and simplifying record keeping. Production could grow more rapidly, unencumbered by supply-chain inefficiencies. As output grew more rapidly than labor input, output per hour of work (productivity, or efficiency) would rapidly expand, generating continuous profit growth. Business, eager to enjoy these rising earnings, would boost output forever.
Of course, that didn’t happen. The efficiencies were real enough and productivity did improve rapidly in the 1990s. But the rapid growth in output prompted business firms to boost hiring, too. When the available pool of potential employees dried up, businesses raided each other for recruits. The resulting bidding war drove up wages and salaries more rapidly than the gains in productivity. The New Economy began to generate rising costs instead of falling costs. Profit margins and profits headed south. The boom was over. The stock market crashed and the economy slid into the 2001 recession.
Those kinds of supply-side clouds are not (yet) on today’s horizon. But the profit margins chart does show a recent wobble. How are today’s problems different from those that generated the 2001 recession? Today’s difficulties are mostly demand-side. Even rising oil prices, which obviously raise operating costs, are a concern because they may lead to reduced consumer spending. If consumers pay more for fuel, they have less to spend on everything else. If existing-home sales slump and real-estate prices fall, the demand for new homes declines accordingly. If credit markets are impaired, the ability to borrow and buy also shrinks. All of these demand-side risks are different from what ailed the economy a decade ago, the last time it confronted a cycle-ending boom. If we’re headed for recession today, it won’t be for the same reasons as last time.
Of course, that didn’t happen. The efficiencies were real enough and productivity did improve rapidly in the 1990s. But the rapid growth in output prompted business firms to boost hiring, too. When the available pool of potential employees dried up, businesses raided each other for recruits. The resulting bidding war drove up wages and salaries more rapidly than the gains in productivity. The New Economy began to generate rising costs instead of falling costs. Profit margins and profits headed south. The boom was over. The stock market crashed and the economy slid into the 2001 recession.
Those kinds of supply-side clouds are not (yet) on today’s horizon. But the profit margins chart does show a recent wobble. How are today’s problems different from those that generated the 2001 recession? Today’s difficulties are mostly demand-side. Even rising oil prices, which obviously raise operating costs, are a concern because they may lead to reduced consumer spending. If consumers pay more for fuel, they have less to spend on everything else. If existing-home sales slump and real-estate prices fall, the demand for new homes declines accordingly. If credit markets are impaired, the ability to borrow and buy also shrinks. All of these demand-side risks are different from what ailed the economy a decade ago, the last time it confronted a cycle-ending boom. If we’re headed for recession today, it won’t be for the same reasons as last time.
1 comment:
Prof. Lehmann:
This post is one of your best but it seems you're off the mark for the reason of the 2001 recession, claiming raising wages (if not skyrocketing) and raiding each others work forces caused productivity to not raise as quickly as wages. Most dot com companies were never profitable, or near profitable, or even brought their products to markets, thus the productivity gauge may not be as useful as the 'greed' gauge of venture capitalists who paid the wages intitially, willfully injected fuel and commentary to pump up the stock market and left regular staffers holding the bag. Once the Victor Charlies (VCs) made their money, they stopped paying the wages and pumping up the stock market, and the phantomware companies that never had any produtivity to measure (because they never had a product) dissappeared.
A recession is coming in the US but is that as important anymore b/c the Eurozone is still bullish?
ps this blogging tool is free, right? The dot com boom produced some extra utility.
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