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Causes of a possible recession

Michael J. Hicks

Economic growth, not recession, is the norm. For every one quarter the U.S. has spent in recession since the end of World War II, we’ve spent eight quarters growing. Of the 75 quarters in this century, only 10 have been recessionary. I’m counting our current quarter as growth, which may prove a bit optimistic.

Economic shocks cause recessions. These might be a war, an oil embargo, a big tax increase or interest rates or the bursting of a financial bubble. This much economists agree on. Where we disagree about the cause of a recession is how this shock is transmitted to businesses and consumers. Some economists believe a recession is due to an optimal response by businesses and households to shocks. Others think the recession comes about because a series of small frictions, like sticky wages or prices keeps markets from adjusting smoothly.

My doctoral dissertation focused on the latter effect, and I remain convinced it is responsible for most recent downturns. The distinction between causes matters really only for the right type of policy to pursue. There is also a rich history of policy mistakes leading up to each, but those are far less intriguing than most folks think. Mostly it is just errors of ignorance or judgement. We learn from these.

In late summer 2019, the world economy is stumbling. We are in the midst of the second largest trade war in history, which has already imposed great costs on American consumers. By winter, it will be the broadest and deepest trade war in history. The annual cost to U.S. consumers stands at more than $1,400 per family, rising through the next round of tariffs. This tariff is a tax on U.S. consumers and has already dampened economic growth. If we are lucky, the U.S. economy will only slow by about one third in 2019. We do not deserve to be lucky.

The frictions of shifting supply chains act as a much bigger drag on production. The predictions by the Trump administration that these policies would return factory jobs to the U.S. were always nonsense. Now that manufacturing production is shrinking at a recessionary pace, the data behind those predictions offer us the chance to relearn some basic truths about trade.

None of this means the U.S. will enter a recession. One reason we might dodge a full-fledged recession is that manufacturing is a shrinking part of our economy. This dynamic is not new. The manufacturing share of both GDP and employment declined steadily for almost a century. Therefore, a manufacturing recession may not cause economy-wide growth to slip into negative range.

Prices on manufactured goods will rise over the next few months. If consumers spend much less, we will have a recession. If holiday packages include pedicures and movie passes in lieu of computers and smart phones, we might dodge that recession.

Recessions are unwelcome, so I hope our nation avoids a business cycle. Our interest rates are near historic lows, and federal spending adds a stimulus of more than $1 trillion per year, which is more than the 2009 Stimulus Bill. We are poorly placed to mitigate a slowdown through federal or monetary policy.

The low share of manufacturing nationwide might spare the U.S. as a whole from recession, but it will not spare manufacturing-heavy states. Indiana, Wisconsin, Ohio and Michigan are already past peak employment, and the big job cuts lie ahead, not behind us. As I pen this column, Indiana has had more layoffs reported in the first week of September than in all of August or July combined.

It seems likely that two, if not three, of these states (including Indiana) will end 2019 with fewer jobs than they saw in 2018. In the post-war period, that has only happened in a recession, and in every recession.

It is important to make clear that the current slowdown is caused by the trade war. There just is not another international event large enough to have generated this slowdown. Trust me, any moderately respectable economist who could find a defensible hint of some other causal factor would find a gleeful reception in some circles.

I am also aware that many Americans believe the trade war is a necessary tool to secure some meaningful national security policy or cause China to behave better in world affairs. Sorry, that is nonsense. The tool for causing China to behave better had a different name. It was called the Trans-Pacific Partnership, a trade deal brokered by both the Bush and Obama Administrations.

This trade war is not a patriotic sacrifice to better America’s prospects in the 21st century. Instead, it is a thoughtless, self-damaging tax pressing much of our domestic economy into slower growth. The trade war weakens our allies, emboldens our enemies and relinquishes the strong moral position the United States has enjoyed since the real sacrifices of World War II.