Global demand is our primary economic issue, not outsourcing or competitiveness.
"We lack a source of demand to keep the economy growing,” said Federal Reserve Chairman Ben Bernanke at a recent GWU lecture. The economic recovery will be slow and unemployment will remain high as long as consumers are not spending and businesses are not investing. And, businesses will not invest as long as there isn't enough demand to warrant it. To strengthen the recovery as much as possible, we must first realize that demand is both the cause and solution to the economic crisis.
People often wrongly suggest that the economic problems we face are due to a lack of competitiveness, leading to outsourcing of jobs; they'll blame taxes (especially corporate income taxes), regulation, education, skills of the workforce, and labor costs, among other things. But, this fails to explain the situation because these things don't happen overnight to cause such economic problems, nor can they result in a global recession. In addition, the U.S. has been dealing with outsourcing for decades, yet still has been perfectly capable of having full employment for most of that time. Instead, the more obvious cause of the economic malaise is the sudden Great Recession, a severe global reduction in economic output (GDP) due to a loss of demand for goods and services.
So why did demand fall in the first place? People often point to the global financial crisis as the cause of the Great Recession. However, this was only a trigger. The economy was already on an unsustainable path before the financial crisis. The crisis was simply a bubble that delayed the recession, making the recession more severe when it suddenly burst. The real root cause was the insufficient growth of middle and lower class incomes to sustain the levels of demand needed to keep full employment. Income growth went increasingly to the wealthiest among us at disparity levels not seen since the Gilded Age that preceded the Great Depression of the 1930's. That is no coincidence.
Wealthier people save a greater proportion of their incomes compared to other income groups that spend a greater portion. As more money is shifted to the wealthiest, there is less consumption, but more money available for investment or consumer loans. However, investment opportunities depend on the existence of sufficient consumer demand. This created lots of investment money competing for fewer investment opportunities and at lower rates of return.
Normally, this situation would lead to a recession as businesses downsize due to insufficient demand, and the risk of investment starts to outweigh the returns. Instead, what happened was Wall Street managed to create a new huge investment opportunity in the form of mortgages, using various techniques that hid the real risk from the investors and even themselves. This boom in housing demand propped up consumption in the economy. But of course, this level of consumption wasn't backed up by enough personal income to be sustainable and would lead to a severe economic crash.
As Bernanke warns, we need a source of demand to bring about a robust recovery. We can start by recognizing this fact and judging budget plans and policy choices on the basis of how they affect demand.