The 2% Economy

A funny thing happened on the way to economic recovery: a slowdown

By Rana Foroohar Saturday, June 04, 2011
    • Illustration by Harry Campbell for TIME

    John Kenneth Galbraith, one of the most famous practitioners of the high-minded guessing game known as economics, once noted that in the dismal science, "the majority is always wrong." How else to explain the fact that so many economists upgraded their growth forecasts for the American economy at the end of last year, often to well above 3%, when the numbers so far this year have come in below 2%? The plunge is due to many things, from higher food and oil prices to supply-chain disruptions in the wake of the Japanese nuclear disaster to a terrible housing market. (The latest Case-Shiller data show that home prices have fallen further than they did during the Great Depression.)

    But the bottom line is that the 2% economy is reshuffling the deck on everything from the debt debate to job growth to the likely outcome of the 2012 elections. Here in the U.S., there won't be many winners.

    To understand why, a little math is in order. When the economy grows faster, tax receipts go up too. That can make a big difference in the debt picture. For example, if the economy grew steadily at, say, 3.9% — which the Fed, in its own moment of irrational exuberance back in February, predicted it might for the year — our national debt (including Social Security and other entitlements) would decline over the next decade from roughly 100% of GDP to a relatively svelte 83%. No more excruciating conversations about cutting Grandma's health benefits or squeezing another five kids into already overcrowded classrooms. If, on the other hand, we grow at 1.8% over the next 10 years, debt rises to 144% of GDP. That makes us Greece.

    Except that we don't have Germany to bail us out. And we have 13.7 million unemployed people. But with debt levels that high, the government would find it impossible to throw any more money at the employment problem. Even now, budgets for things like job retraining and government-sponsored work programs are being whittled back. Add to that mix depressed consumer spending, which in May dropped to a six-month low. That means companies will likely continue to sit on their $1 trillion pile of cash rather than using it to hire more workers. The result is more of what we've already seen — namely, an anemic, jobless recovery. The McKinsey Global Institute predicts that it will take five years to bring employment back to its prerecession peak. In the 2% economy, you can add an additional year or two to that estimate, easy.

    That's bad news for any politician currently in office — from President Obama to the House Republicans, many of whom come from swing districts. "All incumbents have trouble when the economy is down," notes Berkeley professor and former Clinton Labor Secretary Robert Reich. "I'd be concerned if I were in the White House, and if the Republicans had shown any signs of coming up with a viable candidate, I'd be extremely concerned."

    Whatever the election outcome, it's clear that the 2% economy heralds an era of even more divisive, populist politics — both at home and abroad. As low growth ensures that the dollar gets weaker and U.S. wages stay flat, Americans will continue to feel poorer, especially in comparison with faster-growing nations like China, which many Americans blame for taking their jobs. Meanwhile, Beijing will fret about the value of its nearly $3 trillion in foreign-exchange reserves, most of which is held in ever weakening dollars, and leaders jockeying for power in the run-up to a politburo changeover in 2012 will want to be seen as standing up for national interests. All of that is likely to turn up the heat on the usual trade and currency battles between Washington and Beijing, which could be growth-damaging if it leads to a new bout of protectionism. That is the worst characteristic of the 2% economy: its effects tend to snowball.

    Of course, there are still economists who say growth will pick up toward the end of the year. (Though if Galbraith is right, the more who do, the more we should worry.) Whatever happens, there's no changing the bigger trend line. The U.S. and the world are in the middle of an economic rebalancing that hasn't been seen since the rise of the great European empires in the 1500s. Power is shifting from West to East, technology is rejiggering the relationship between growth and jobs, and both trends are intersecting in ways that have undercut the upward trajectory of our economy. It's uncharted territory, in which policymakers and economists alike are flying blind. Dismal science, indeed.

    This article originally appeared in the June 13, 2011 issue of TIME.