The W Scenario

SYNOPSIS: We aren't out of the recession yet

First comes the victory parade. Later we'll find out if we won.

Celebrating victory well in advance seems to be the style lately. And that includes the economic front. Both the administration and many business leaders have taken a modest improvement in economic indicators as proof that the economy is poised for full recovery. They could be right but don't count on it.

The good news to date consists mainly of evidence not that things are getting better but that they are getting worse more slowly. New claims for unemployment insurance have fallen; that means fewer people are being laid off, but not that laid-off workers are finding new jobs. Industrial production has stabilized; that means that companies have worked off the excess inventory that led them to slash production in 2001, but not that demand for their products has increased.

We won't have a serious recovery until what economists call "final demand" shows substantial increases, and workers start being rehired. Where will that recovery come from?

This has not been a standard recession, in which nervous consumers pulled back and will start spending again once they have been reassured. In fact, consumers have continued to spend freely right through the slump. So the surge in consumer demand that usually drives recovery seems unlikely.

What drove this recession was a plunge in business spending, as companies realized that they had over invested in the bubble years. Thus far there is very little evidence that companies are willing to start spending again anytime soon. And even if they did feel like spending, banks and financial markets, spooked by the Enron scandal, are reluctant to make the money available.

The only clear force for recovery I see is the administration's military splurge. After all, even useless weapons spending does create jobs, at least for a while. Japan props up its economy by building bridges to nowhere; the Bush administration buys Crusader artillery systems and F-22's.

Against this, there are at least three important forces that will place a drag on the economy.

First is the impact of unemployment. The number of Americans without jobs seems to have stabilized, but their pain is growing: more and more of the unemployed have been without jobs for months rather than weeks, and a rapidly growing number have exhausted their benefits (which House leaders have refused to extend). Will consumer demand remain robust as the human toll of recession becomes increasingly apparent?

Second is the plight of state and local government. The Pentagon may be getting everything it wants, and then some, but state and local governments are desperate; they will be slashing spending, laying off workers and even raising taxes all with depressing effects on the economy.

Finally, there's line 47. You haven't heard about that, but you will.

Here's the story. The Bush administration didn't want to give those famous $300 rebate checks; its original plan would have pumped hardly any money into the economy last year. Under prodding from Democrats the plan was changed to incorporate immediate cash outlays. But those outlays were included only grudgingly, and with a catch: they really weren't rebates. Instead, they were merely advances on future tax cuts.

What that means is that most taxpayers, when they reach line 47 of their 1040's, will discover that they owe $300 more in taxes than they expected. In other words, the one piece of the Bush tax cut that probably did help the economy last year is about to be snatched away. The direct monetary impact will be significant; the psychological impact, as taxpayers realize that they've been misled, may be even greater.

Many forecasters think that the impact of these drags on the economy will be a recovery that is slow and generates so few jobs that it feels more like a continuing recession. A few analysts notably Stephen Roach of Morgan Stanley, who deserves a medal for his dogged skepticism about the "new economy" during the bubble years think that we're headed for a "W-shaped" or "double-dip" recession, in which we have reached a bottom but not the bottom.

Personally, I find the pessimists more convincing than the optimists though any economist who honestly keeps track of his own forecasting record quickly learns to be humble. What's certain is that it's much too soon to declare victory.

Originally published in The New York Times, 2.22.02