Two US Economic Recoveries: One Is V-Shaped, the Other Is Not

It looks like the Great Recession did indeed produce the much-anticipated V-shaped recovery—although not the way some economists predicted. US corporations experienced the V shaped recovery, while US workers experienced virtually no recovery (see the circled areas in figures 1 and 2). The ratio of corporate profits to private industry income is at its highest rate since 1948.¹ At the same time, the ratio of total employment to the working age population is at its lowest rate since 1983.

According to the Bureau of Economic Analysis, US corporate profits in the third quarter of 2011 reached an annual rate of approximately $2 trillion, close to 18 percent of total national income by private industry.² Although corporate profits are at a historic high—in both absolute value and relative to private industry income, private nonresidential fixed investment in plant and equipment (P&E), which is traditionally understood to be a prerequisite for improvements in job creation and productivity, remains low.³ (See figure 3). At barely above 10 percent, the ratio of private investment in P&E to GDP helps explain the low ratio of total employment to the working age population.⁴

Legitimate concern over the robustness of the current recovery should not overshadow the relative performance of the actual components. The decline in residential investment has been well documented. A comparison of the last two years against the first two years of the last three expansions finds that the other weakness in aggregate demand is in government consumption, not in personal consumption. And although improving, private investment in P&E has been growing at only half its rate during the outset of the 1980s expansion. The enormous run-up in corporate profits suggests that the growth in private investment is not being constrained by a lack of capital. On the contrary, real interest rates are barely positive.

Figure 1

Figure 2

Not all economic expansions are created equal. Just as recessions differ in length and depth, so too can economic expansions be very different. The following analysis finds vast differences between the last three complete US economic expansions—the Reagan expansion (1983:I to 1990:II), the Clinton expansion (1991:II to 2000:IV), and the Bush expansion (2002:I to 2007:III). (See table 1).

While President Reagan and his economic advisors were championing the virtues of "supply-side" theories during the 1980s, the US economy was experiencing a classic demand-side expansion. The average quarterly growth rate for personal consumption, residential investment, and government consumption combined was 1.9 percent. By contrast, private investment in P&E —an indicator of the economy's supply-side—grew on average by only 1.4 percent per quarter, causing private investment as a percent of GDP to initially rise from a low of 11.6 percent in 1983:II to a peak of 12.7 percent in 1984:IV, before falling back to a historic low of 10.7 percent by the end of the expansion in 1990:II (see figure 3). The employment to population ratio rose 6 points during the Reagan expansion, from a low of 57.1 percent in 1983:I to a high of 63.1 percent in 1990:I.⁵ The ratio of corporate profits to private industry income was relatively flat during the Reagan expansion, rising by only 2.3 points during the Reagan expansion, from a low of 9.1 percent in 1983:I to a high of 11.4 percent in 1988:IV.

Figure 3

In contrast to the Reagan expansion, the Clinton expansion was a true supply-side expansion, based on very strong growth in private investment in P&E and weaker growth in aggregate demand, primarily resulting from a slowdown in government spending outside of transfer payments. Investment in P&E as a percent of GDP rose 3.4 percentage points during the Clinton expansion, from a low of 9.5 percent in 1992:I to a high of 12.9 percent in 2000:III.⁶ Average quarterly employment growth during the Clinton expansion was actually lower than it was during the Reagan expansion. The expansion's major achievement was the strong growth in real hourly compensation. The employment to population ratio rose 3.2 points during the Clinton expansion, from a low of 61.4 percent in 1991:IV and 1992:I to high of 64.6 percent in 2000:I. By contrast, the ratio of corporate profits to private industry income fell by 4 points, from a high of 14.1 percent in 1997:III to 10.7 percent in 2000:IV.

The Bush expansion was based on slow growth in both the demand and supply sides of the economy. The average quarterly growth rate for personal consumption, residential investment and government consumption combined was 1.4 percent and the average quarterly growth rate for private investment in P&E was 1.5 percent. Of the three, the Bush expansion produced the weakest employment growth and only moderate growth in real hourly compensation. The employment to population ratio rose only 1.2 points during the Bush expansion, from a low of 62.1 percent in 2003:III to a high of 63.3 percent in 2007:I. Investment in P&E as a percent of GDP rose by only 1.7 percentage points during the expansion, from a low of 10.1 percent in 2004:I to 11.8 percent in 2007:III. The real distinction of the Bush expansion was strong growth in corporate profits—the ratio of corporate profits to private industry income rose by 5 points during the Bush expansion, from a low of 10.5 percent in 2002:I to 15.5 percent in 2006:III.

These stark differences among the Reagan, Clinton, and Bush expansions outlined above were not evident from their outset. An analysis of the first eight quarters of the three economic expansions, in addition to the first eight quarters following the 2008–09 recession—the "Obama expansion"—finds that the initial two years of the Reagan expansion were the strongest of the last four expansions (see table 2).

Thus far, the Obama expansion can be characterized by relatively strong private investment in P&E and relatively weak aggregate demand, primarily caused by significant slowdowns in government consumption and residential investment. Contrary to conventional wisdom, the average quarterly growth in personal consumption over the last two years was consistent with what it was during the outset of the Clinton and Bush expansions. On the other hand, the average quarterly growth in residential investment (-0.2 percent) has been significantly less than it was during the outset of the Reagan (6.5 percent), Clinton (3.3 percent), and Bush (3.2 percent) expansions.

Contrary to claims of "big government," the average quarterly growth in federal government spending (outside of transfer payments) over the last two years (1.1 percent) was significantly less than it was during the outset of the Reagan (2.2 percent) and Bush (2.7 percent) expansions. The average quarterly growth in state and local government spending outside of transfer payments (0.2 percent) was the lowest among the outset of all the expansions, i.e., Reagan (1.8 percent), Clinton (1.0 percent), and Bush (1.0 percent) expansions.

Private investment in P&E has been one of the only bright spots in an otherwise lackluster recovery. The average quarterly growth of private investment in P&E during the first eight quarters of the Obama expansion is significantly higher than it was during the outset of the Clinton and Bush expansions, but only half the rate experienced during the outset of the Reagan expansion.

The first two years of the Obama expansion stand out because of significant growth of corporate profits and the poor performance in the labor market. Average quarterly growth of corporate profits over the last two years was significantly higher than it was during the outset of the Clinton and Bush expansions, although a little less than it was during the outset of the Reagan expansion.

In contrast to corporate profits, there has been virtually no improvement in the labor market, as the average quarterly growth of total nonfarm employment over the last two years was -0.1 percent, the lowest of all the expansions. Given the differences outlined above, it is not surprising that the current expansion lags behind the first two years of the previous three expansions in terms of productivity growth, improvements in real hourly compensation, and overall GDP growth.

Notes

The record is clear—policies aimed at expanding federal, state, and local government spending and private investment in P&E are necessary in order to get the Obama expansion on track.

1. The Department of Commerce began collecting and reporting data on corporate profits and private industry income in 1948.

2. Corporate profits with inventory valuation and capital consumption adjustments, before taxes.

3. It is beyond the scope of this brief note to explore the causal relationship between investment in P&E, job creation, productivity, and wages in detail.

4. Under current conditions, the ratio of employment to the working age population provides a more accurate picture of the labor market than the unemployment rate.

5. This is difference between low and high point during expansion, not the change from beginning to end of expansion cited in table 1.

6. The last time the ratio of private investment in P&E to GDP reached this high was in 1982:II.