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Economic forecast

By John Harvey
Professor of economics

In a few harrowing hours on Sept. 11, our world changed.

Americans' sense of security was replaced first with horror, then rage, and, finally, a sort of cautious determination to overcome. If we ever regain our earlier feeling of invulnerability, it won't be any time soon.

Meanwhile, though those of us thousands of miles from ground zero may feel pangs of guilt for returning to "business as usual," return we must.

But have the attacks on the World Trade Center and the Pentagon precluded a return to normality by ushering in a period of stagnation and decline? Or will the terrorists ultimately fail in their attempt to crush our economic well-being along with the physical symbols they attacked on that Tuesday?

Predicting the post-Sept. 11 world requires a quick review of what we faced before 8:45 that morning. It was not terribly positive. The long expansion, based initially on private investment spending and then, in its waning months, on consumer-led, debt-financed purchases could not be sustained indefinitely. A significant portion of the spending was on durable items, which do not need to be replaced often, but at the same time household debt (as a percentage of household income) was rising to unprecedented levels. At some point, families were going to decide that it was no longer prudent to add new debt, or financial institutions were going to make that decision for them.

In fact, by the second quarter of this year it was clear that consumer spending was on the decline. Coupled with the fact that unemployment had risen to 4.9 percent, this led to a fall in consumer confidence and an increasing likelihood that the major factor underlying our expansion was going to be pulled out from under us.

Meanwhile, the other two most likely agents for stimulative expenditures -- the trade balance and the federal budget balance -- were continuing to be net drains on economic activity. Some prominent forecasting centers said we were already in recession. We were certainly close, with the Bush tax rebates the only clearly positive sign for the future (and at that, most economists thought they would be insufficient). And then came the attacks.

Is there going to be a recession now? Yes. There was going to be one anyway; the terrorists just dictated the timing.

Consumer confidence is bound to dip further, continuing to erode the foundation of our recently deceased economic boom, and the volatility and depression of stock prices since the market's reopening are evidence that business confidence has been shaken. Furthermore, the fear that something else might happen, as loathe as we may be to say it out loud, will be there for some time to come, preventing us from putting this episode completely behind us.

Meanwhile, the impact on airlines and the travel industry has been immediate and devastating. From rising insurance costs and the need to meet new federal safety regulations, to mass cancellations of conventions and a general decline in tourism, they have been hit with a simultaneous rise in their costs and decline in their revenue. They have responded with their only apparent option: layoffs. This is bound to have multiplier effects, and taken in combination with the downturn we were already experiencing we will see higher unemployment. The Levy Economic Institute in New York estimates that it may reach 7 percent next year, a number we have not seen since 1993. Another certain impact will be a ratcheting up of costs in air travel and transport, which may cause inflationary pressures in the rest of the economy (though likely minor).

But not all the news is bad. Though I admit to being biased by an optimistic nature, I would argue that there is more economically to look forward to than to dread. To begin, the actual physical damage was very localized and, in terms of our national ability to produce goods and services, incidental. Ours is still the largest and most productive economy in the world and it would take many times what happened on Sept. 11 to change that.

Second, for the time being our supplies of oil seem to be reasonably safe -- we have no need to fear oil-shock inflation.

Third, both the rebuilding of the devastated areas and the need to add new safety measures and increase military readiness will create employment exactly at a time when we need it.

Last and most important, the primary driver behind all this will be the only sector in a position to restart our economic engine: the government. Entering the fall of 2001, there was some debate over which was more important -- avoiding recession through increased government spending or preserving the federal government's budget surplus. As of Sept, 11, that debate ended.

This bodes well for the future. The key problem in a modern capitalist economy is finding sufficient work for all willing bodies. Just as during the Great Depression, we have the productive capacity to feed, clothe and shelter everyone -- the trick is finding them something to do that will justify them a share of (i.e., give them the income necessary to purchase) those goods and services.

Through the 1930s our real problem was a psychological one. We, as a nation, were unable to justify to ourselves the level of government spending in the economy that was necessary to solve the problem. Pearl Harbor solved our dilemma, in dramatic fashion. Overnight, the Depression was over because jobs were created in abundance.

In the second week of September 2001, an economic slowdown that was already under way was combined with confidence-shattering terrorism. In the days and months following, we cannot expect the entrepreneurs of the private sector to be forthcoming with job offers for the millions who now and soon will stand unemployed. They cannot afford it. But from the problem emerges part of the solution. Like Dec. 7, 1941, the debate over the proper role of government is moot. In fact, given the speed with which the government is already spending to shore up defenses and relieve the plight of those directly affected, it appears that our emerging recession might even be shorter than it would have been without the World Trade Center and Pentagon attacks. I doubt that was the terrorists' intention.

Good.

John Harvey is a professor of economics. He was awarded the Dean's Award for Distinguished Teaching in 1998. E-mail him at j.harvey@tcu.edu.