How Long Can Consumers Keep Spending?

The New York Times

CAMBRIDGE, Mass. -- The old industrial struggle was between companies and workers. The new struggle is between . . . companies and workers. But the battle isn't what it used to be. Now, it's over who's going to spend enough to keep the economy moving forward. The crunch will come if companies lay off so many employees that consumers go on a spending strike.

Since last year, American companies have cut way back on their purchases. The economy isn't in recession only because consumers haven't cut back their spending as well. If they do, the American economy tanks.

A slowdown usually starts the other way around. Consumers reduce their spending because they've used up too much of their savings and can't afford or don't want to borrow more. Then companies cut back their own spending because sales are down.

This time, companies started it. They overspent in the late 90's, mostly on capital equipment and software, and then began cutting back last year at the first sign of trouble. The technology sector took the biggest hit. As profits continued to drop this year, companies stopped buying. Business investment dropped a whopping 14.6 percent in the second quarter. Investment in equipment and software fell by 15.1 percent in the second quarter, the largest drop since the comparable period of 1982. Even outside the battered technology sector, profits have been disappointing. As a result, companies have begun to target their biggest single cost -- payrolls.

Last year the economy gained 1.76 million jobs. But between March and July of this year it shed 394,000 in the private sector -- the largest monthly drops since the recession in 1991 and 1992. (We won't know what happened in August until figures come out later this week.) Since April 1998, when factory payrolls peaked, 1.2 million factory jobs have been lost. But the biggest surprise has come in the service sector. Service jobs had grown steadily for decades, recession or no recession, but since March, the number of service jobs in the American economy has not grown at all.

The job losses look even bigger when considering forthcoming layoffs. In July, companies announced that they would lay off an additional 205,975 workers, a monthly record.

Even if companies are cutting way back, the economy can still move forward as long as consumers keep spending. After all, consumer spending accounts for two-thirds of all economic activity. In the second quarter of this year, consumers increased their spending at an annualized rate of 2.1 percent. That's a bit slower than in the first quarter but good enough to keep the economy going.

But there's an obvious tension here that lies at the heart of the economy. If the job cutbacks and layoffs continue, at some point consumers are going to get worried about their own paychecks. And when that happens, they'll cut way back on spending.

This belt-tightening could happen suddenly because consumers are already deep in debt. Consumer-credit debt surged a whopping 9.3 percent last year, and it is still rising at that torrid pace. Personal debt has been growing by an average annualized rate of 8.2 percent a month since last October. Mortgage debt is way up, too.

The interesting question is why employees have remained so irrationally exuberant. Surely not because they're getting a few hundred dollars in tax rebates or because fuel prices have eased. The easiest explanation is that the last recession is only a dim memory, so most people underestimate the risk of losing a job and hitting the wall. Almost a quarter of the current work force wasn't even old enough to have a job when the last recession blew through in 1991 and 1992. Since then we've enjoyed one of the longest periods of prosperity on record. Millions of Americans were lifted into the middle class. The rate of home ownership rose to 67.5 percent, the highest on record. Homes are Americans's biggest nest egg, and housing prices are still holding firm. So naturally there's a lot of wishful thinking that the economy will bounce back soon.

Moreover, the latest round of job cuts doesn't seem nearly as threatening as it might have years ago. By now, people are used to the idea that they might be laid off. During the 90's, the possibility of losing one's job became a permanent feature of working life. High rates of layoffs that began in the recession of 1991-92 never dropped by much. The difference was that as the economy gained speed in the 90's, people who lost their jobs could easily find new ones. Unemployment dropped to its lowest rate in three decades. But now, jobs are becoming harder to find.

Finally, after a decade of prosperity, most people have become used to a certain standard of living. They'll pull in their belts only when they feel they have no choice -- that is, when their bills grow too large or when their jobs seem at risk.

Every announcement of more layoffs moves us closer to that moment. Consumers are already slowing their purchases of cars and other big-ticket items, according to the latest confidence surveys. If the job cuts keep up, at some point consumer confidence will take a dive, and consumers will go on a spending strike. When that happens, not even Alan Greenspan's interest rate cuts can help us.

Blather about whether the economy has ''bottomed out'' is meaningless. The economy might take off again, but it also might fall into a full-blown recession. It all depends on whether the Federal Reserve's rate cuts, combined with additional government spending (don't worry about the Social Security surplus, please!) encourage companies to start spending again and stop cutting payrolls before employees lose their irrational exuberance and become rationally worried.

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