Over the past 5 years or so, economists and pundits have been puzzled with the sluggishness of the current economic recovery. This recovery has been so anemic to the point that more than half of all Americans still thought that the economy was in a recession, as of March of this year. Economic historians have noted that every economic recovery since the 1970’s has seemed to get weaker and weaker than the previous one. One historian has even noted that the reason unemployment fell to an extremely low 4% in the previous two recoveries (1992-2000, 2002-2007) is that the expansions lasted so long allowing for the accumulation of jobs, thereby masking the weakness of the job growth. This is in contrast with the immediate post-war recessions in which the downturns were met head-on with the Fed lowering interest rates and the economy resuming robust job growth shortly thereafter. However, economists have not been able to put their finger on what exactly changed and why public policy has not been able to engineer similar recoveries as it seemed to be able to in the immediate postwar period.

I think that when one is looking as to why the same policy (i.e. the Fed lowering interest-rates) does not have the same effect over various time periods, the answer lies in the underlying conditions in which the policy is being attempted. What is extremely clear is that the underlying economic structure of the United States has changed since 1980.

First of all, we are much less industrialized economy and more of a service economy. It is possible that an economy that makes things is more responsive to changes in interest rates than one in which specializes in intangible type services. While it may not be abundantly clear why this would be the case, it could be that investments in production capacity anticipate economic expansion, whereas those in service type businesses react to economic expansion. For example, service-type businesses often have labor as their main factor of production, which means that firms often wait until their existing workforce is stretched before adding service providers. This means that service companies will tend to be adding workers later in the expansion cycle, all things being equal, than a production business which has to make a guess on what future orders will be, hire the people, buy the raw material, produce the product, and then hope that the demand is there.

Second of all, the last 30 years has seen a massive growth in business regulations. While regulations were growing for decades prior to 1980, they have continued to grow. It could be the mountains of regulations have simply started to weigh down the economy so that it can’t recover as fast due to growing red-tape. We do know that if you start from an unregulated economy and start adding regulations over time, eventually you will reach a point at which your economy will slow, then stagnate, and then, in an extreme case (i.e. the Soviet Union) collapse. While we may not be at the Soviet Union stage, the fact is that there has been no major rollback of regulations for decades. And consider for a moment all of the regulations that have been written since 1999. We lived very well in 1999 without any of the regulations that have been added since then, and we did so very, very, well. Which leads one to ask, were all of the new regulations (which impose an economic cost) that have been instituted over the last 15 years really necessary?

Finally, there is the matter that trade has become freer, economies that were previously closed (Soviet Union, Eastern Europe & China) that have entered the international arena to compete with the U.S. American companies have been able to outsource work overseas (even some service jobs) that they were not able to do before. This means that any given economic expansion will mean more jobs in the U.S. and more jobs overseas to meet U.S. demand, whereas previously it meant more U.S. jobs to meet U.S. demand. While this is highly simplified, and while freer global trade has meant cheaper goods for U.S. consumers, at some level it has meant fewer U.S. jobs in an expansion than would likely have been the case a generation ago.

Overall, the sluggishness of the U.S. economy is likely due to these factors, as well as other factors that I haven’t mentioned. One thing to notice though is that for all of the political squabbling about the economic policies of this Administration or the previous Administration the factors that I have mentioned preceded either of the Administrations and are largely factors beyond the control of any given Administration, Democrat or Republican. While there are certain things a given Administration could do to improve the situation (i.e. roll back regulations), we will likely never return to the 1945-1980 era economically because the world has fundamentally changed. Get used to sluggish recoveries.