The Green Shoots are Dead

The June US employment report
should convince even the determinedly ignorant that the time has come
for another round of stimulus for the American economy. The economy is
continuing to shed jobs and work hours at a very rapid pace. The
unemployment rate is virtually certain to cross 10% by the end of the
summer and will likely hit 11% before we are very far into 2010. This
is a scenario much worse than the Obama administration had expected when it crafted its stimulus package. It is time for it to adjust its plans accordingly.

When
the Obama administration put together its stimulus package in January,
it was projecting that, in the absence of any stimulus, the
unemployment rate would peak at just over 9% early in 2010. With the
unemployment rate reaching 9.5% in June, they clearly underestimated the size of the downdraft hitting the US economy.

The
June data showed the economy shedding 465,000 jobs - but even more
striking was the fact that hours worked fell by 0.8%. This rate of
decline in hours worked is the same as in the period of economic free
fall from October to April. It's good that employers cut back hours per
worker, rather than lay people off, but it still means that the demand
for labour is plummeting. If hours per worker did not change, this
would be equivalent to a loss of more than 900,000 jobs in June.

While
few would argue that the economy is already turning, some economists
maintain that we have to wait longer to feel the full effects of the
stimulus package. To refute this argument we need only look at the size
of the package.

More than 60% of the stimulus package ($480bn
out of $790bn) was in the form of either tax cuts or mandatory spending
such as expanded unemployment benefits. These tax cuts and spending
measures have already fully kicked in. While most of the money has not
yet been spent, we are already paying taxes at a lower rate, due to the
tax cut, and collecting higher benefits as a result of the stimulus
package.

Consumption in April, May, and June was undoubtedly
higher as a result of these stimulus measures, but there is no reason
to believe that they will provide further additional boost in July,
August, and September. In other words, we are now feeling the benefits
of this stimulus, and we will continue to feel the benefits. But it is
just not sufficient to offset the downward momentum from the collapse
of the housing bubble.

If we expect a further boost from the
stimulus, then it has to come from the direct spending portion. As many
commentators have rightly noted, most of this money has not yet gone
out the door. However, the amount at issue is too small to have much
impact.

The Congressional Budget Office projects that we will
spend $110bn from this portion of the stimulus package in the fiscal
year beginning in October. However, almost $30bn of this spending is
designated as a state and local fiscal stabilisation fund. This money
will prevent cutbacks at the state and local level. This is very useful
spending, but this money is just preventing further contraction, not
pushing the economy forward.

That leaves us with just $80bn as a
net stimulus for 2010 compared with current tax and spending levels.
This is just a bit more than 0.5% of GDP. It is less than one-fifth as
large as the falloff in housing construction from its peak at the
height of the bubble. It is only a bit more than one-tenth as large as
the falloff in consumption due to the disappearance of housing bubble
wealth. In short, it cannot possibly be large enough to turn the
economy around.

This is why we badly need a third stimulus
package. There is nothing on the horizon to prevent the unemployment
rate from staying high long into the future. As I have written before,
the obvious form for a third stimulus would be an employer tax credit
to give workers paid time off.

This
"pay for play" tax credit would give employers an incentive to shorten
work time with paid family leave, paid sick days, paid vacations and/or
shorter workweeks. It is likely to have an impact very quickly, since
employers would be throwing money away by not moving as quickly as
possible to take advantage of the tax credit. As a result, it would
both put more money into the economy and also redistribute employment
so that fewer workers are unemployed. If we all worked five per cent
fewer hours, then seven million more workers could have jobs at the
same level of demand.

The people who make economic policy gave
us this recession because they were too bullheaded to see an $8,000bn
housing bubble right in front of their face. There are ways to get us
out of the mess they created, if our leading economic policymakers
could finally start to open their eyes and think seriously about the economy.