(Bloomberg News) The continuing weakness in the labor market and the never-ending saga of the debt limit highlight the dual problems we face: low economic growth right now and an unsustainable amount of debt for the future. Unfortunately, both problems are probably more significant than policy discussions and official predictions about the U.S. economy suggest.
The history of economies recovering from severe financial distress implies the unemployment rate will remain stuck at elevated levels for years, not quarters. And sluggish growth, in turn, will mean larger budget deficits.
Under a plausible hard-slog scenario, the fiscal gap would exceed $13 trillion over the next decade, without a change in government policies. That's at least $2.5 trillion more than the deficit with official economic assumptions -- a difference that itself will probably be larger than any deficit reduction that comes from the debt-limit deal. So it's worth exploring the implications of slower growth in more detail.
One important way in which the official projections may turn out to be too optimistic involves unemployment. The fundamental impediment to getting jobless Americans back to work is weak growth. Yet that is the norm rather than the exception after the type of experience we have lived through. Recoveries following financial collapses tend to be frailer than those associated with other sorts of economic declines.
As a result, unemployment is likely to remain stubbornly high for a significant period. Consider the other advanced economies that have experienced financial implosions similar to the one we had: Spain in 1977, Norway in 1987, Finland in 1991, Sweden in 1991 and Japan in 1992.
The economists Carmen and Vincent Reinhart found that in all five of these countries the unemployment rate has still not fallen back to pre-crisis levels, even today. The peak was reached from three to 10 years after the meltdown. And the median increase in the jobless rate across these countries in the decade following the implosion was, astonishingly, more than five percentage points.
Unemployment Predictions
What do our official projections suggest? The Congressional Budget Office, which I have had the privilege of leading and which provides an objective set of economic and fiscal projections, offers an example. For the decade ahead, the CBO expects an average unemployment rate of 6 percent -- up only one percentage point from the average of about 5 percent before the 2008 crisis. Sure, our labor markets are more flexible than those in most other countries, and that should help reduce the jobless rate relatively rapidly here. But given the experience of other countries that have endured similar financial collapses, that performance would still be extraordinary.
The declines in unemployment predicted by CBO, as well as the Federal Reserve and other government institutions, arise because these agencies continue to anticipate growth rapid enough to drive down the jobless rate significantly from its current 9.2 percent level. As time goes by and the expected fast expansion in gross domestic product doesn't materialize, projections simply delay the robust growth for another year.
The risk in using this methodology is that it misses the deeper structural hurdles our economy faces that can depress growth over a prolonged period -- including the still-depressed housing market and the adverse effects of deleveraging.