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Recession Time? Don’t Act Surprised

Treasury Secretary Yellen does not see any indicator of an imminent recession. 
She isn’t looking.  The normal economic tailwinds have calmed and, as predicted, Biden’s economic policies are a significant headwind.

A recession is sometimes defined
as a reduction in the number employed nationally for a couple of months.  Other times it is defined as a reduction in real
GDP for two quarters or more.

When it comes to predicting
events like this, my recursive approach is to first understand where the
general trends are heading.  In technical
terms, is the economy’s “steady state” above or below where we are now, and how
much?  If the trends are strong up, small
perturbations around that trend will not make a recession.  If the trends are flat, then even a small negative
shock will create a recession by one or more of the definitions.  Which definition will be triggered can be
assessed by contrasting employment trends with productivity trends.

Four important trends are worth
considering: organic productivity growth, organic population growth, recovery
from the pandemic recession, and new public policies affecting productivity,  population,
or employment.

Organic trends

Given that recessions are defined
in absolute rather than per capita terms, population growth is normally an
economic tailwind.  However, annual adult
population has fallen from a bit above one percent 1980-2018 to about 0.4
percent.  Illegal immigration is a wild
card here because we do not know how many are immigrating, what fraction are adults,
and whether and how those adults will be economically engaged.  With that caveat, we now are in a situation
where even a small negative shock that would not have caused a recession in the
one-percent population growth era will now.

Recovery from the pandemic was
also a tailwind.  It someday will
continue to lift employment, but at the moment it
looks like employment has recovered as much as it can given
the serious health problems encountered during the pandemic, including but not
limited to self-destructive substance abuse habits that are not complementary
with productive employment.  Some of
these people will show up on payrolls but how reliably they show up for work is
another question.  Diabetes, liver
disease and heart disease have gotten out of control since 2020.

Workers lost skills and capital
laid idle during the pandemic.  These are
recovering, although their recovery will not be fully recognized in the growth
data.  GDP and productivity levels were
exaggerated during the pandemic as many goods were unavailable or low quality
in ways not captured by the national accountants.  For example, public school teachers stayed
home from school but the national accountants assumed
that they were as productive as ever merely because they continued to get
paid.  As they get back to traditional
teaching, this will not be officially recognized as economic progress for the
same reason the pandemic regress was never acknowledged. 

Crime has gotten bad, especially
in big cities where productivity is normally the highest.  Consumers and businesses are avoiding big cities,
which is a cost (“excess burden”) beyond the crime statistics because the whole
point of the avoidance behaviors is to keep from being one of those statistics.

Fitzgerald, Hassett,
and I predicted
in 2020 that Biden’s economic agenda would reduce the levels of full-time
equivalent employment per capita by 3.1 percent and real gdp
per capita by 8.5 percent.  If that level
effect were spread over five years, that would be 0.6 percent per year and 1.7
percent per year, respectively, as shown in the Table as an addendum panel.  That by itself makes a recession likely in
one of those five years.

Regulatory Policy

Our analysis of Biden’s agenda distinguished
regulation from capital taxation from labor taxation.  His regulatory agenda seems to be going ahead
as we expected.  The good news is that Biden’s
nomination of David Weil to the Department of Labor was rejected
by the Senate and Biden was slow to fully mismanage the National Labor
Relations Board.  But we did not anticipate
that Biden’s DOL would disrupt labor markets as much as it did with its mask
mandates.  Sticking
with our original estimate, it
looks that Biden’s regulatory agenda is
reducing employment by 0.2 percent per year (of five years) and real GDP by 0.7
percent per year below the organic trends. 
See the Table’s top panel.

Of particular concern over the
next few months is the reliability of the
electric grid and air
travel.  Snafus of this type are
already built into our regulatory analysis but these examples put more texture
on the economic reasoning that links the marginal regulations with poor
economic performance.

Capital Taxation: Inflation Sneaks

Biden’s Build Back Better bill
would implement much of the capital taxation we envisioned in 2020.  The good news is that the bill has not yet
passed, and passage of its capital tax elements are not imminent in some other
form.  The bad news is that inflation is
taxing businesses without any Congressional action (recall Feldstein
and more
recently Hassett on the effect of inflation on
the cost of capital), while it appears that Biden will let temporary provisions
in the 2017 TCJA expire.  With capital
taxation during the Biden administration increasing about half of what we
expected, it would reduce real GDP by about 0.4 percent per year over five

Speaking of inflation, higher Fed Funds rates are already showing up in mortgage rates.  In effect, the Federal Reserve is introducing a tax (or cutting a subsidy) on structures investment, which is likely to send at least that sector into a recession.  Socially responsible (a.k.a., woke) investing is also skewing the allocation of capital.

Combining capital taxation and
regulation, the headwinds in the Biden economy are 0.25 percent per year for
employment and 1.1 percent per year for real GDP.

Labor Taxation: Direction

Labor taxation is an interesting
wild card here.  Marginal tax rates on
work were cut sharply when the $300 weekly unemployment bonus expired last
summer.  That effect has played out
already.  But I expect that Congressional
Democrats, and even some Republicans, will expand unemployment benefits if
anything resembling a recession were occurring. 
That could easily and quickly reduce employment by one percent, if not
more.  On the other hand, various federal
health insurance subsidies are about to expire. 
If they do (without resurrection), that will encourage work.

Bottom Line

Overall, a recession is highly likely
with so many headwinds and so few tailwinds. 
A recession is more likely by the GDP definition than the employment
definition.  The depth of the recession depends
on how much Congress destabilizes things by further adding to the already large
federal portfolio of programs for the unemployed and poor and further adding to
tax burdens.

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