Summers: "People Forget Just How Close to the Edge the Economy Was''

Now in mid-summer, as the Dow Jones industrial average crossed the 9000 mark for the first time since Barack Obama was inaugurated, it is easy for most voters to forget the white-knuckle fears of economic collapse. As Summers said in a Thursday afternoon interview, "The combination of complexity of the economy and the quality of human nature -- which for evolutionary reasons smoothes over excruciating memories to make us all happier -- has led to a situation where people forget just how close to the edge the economy was last fall and early this winter."

This was said less in a mood of triumphalism and more as an acknowledgment of the realities of what the nation – and the world – had weathered. While no president and no economic adviser is ever dismayed by a rising stock market, Summers cautioned against using the Dow as a measure of policy success because markets are naturally so volatile.

"When the Dow was around 6,000, we made clear that our goal was to develop economic policy based on the long-run fundamentals – trying to put in place productive capacity," he recalled. "And that you couldn't judge the policies based on day-to-day market moves. That was the right and responsible approach." Summers' implicit message is that the current jump in share prices should embarrass the administration's critics, who painted a dire portrait of the Obama economy based on a 6600 Dow in March.

In a speech last week at the Peterson Institute for International Economics, Summers pointed out that the current 9.5 percent unemployment rate was "about 1 to 1.5 percentage points more than would normally be attributable to the contraction in the [economy]." In other words, something is screwy with the standard forecasting models, since layoffs have been much more severe than would be expected with the decline in the economic output, or Gross National Product (GNP). This was a major reason why the administration's economic forecast in January had erroneously predicted that unemployment would not rise above about 8 percent this year.

In his Thursday phone interview with me, Summers amplified his remarks about the breakdown of the traditional relationship between GNP and the jobless rate. "What's noteworthy about this recession is that GNP over the last six months has been only marginally worse than people expected it would be in January, while we are experiencing higher than expected unemployment," he said. "Normally in economic downturns, productivity decreases as firms keep workers employed even as the amount of work declines. In this recession, as in the last one, productivity has actually increased."

Traditionally, as the economy gathers momentum after a recession, jobs are slow to bounce back, a lagging indicator in economic lingo. What is difficult to figure this time around – and Summers acknowledges that there is not yet enough data to make a determination – is how reluctant businesses will be to hire new workers. It can be argued that because the layoffs were so much faster and graver than the economic models would suggest, the recovery in jobs will be equally accelerated. But there is also the more alarming prospect that companies are growing adept at doing more with fewer workers (the equivalent of an old-fashioned speed-up on the assembly line) – and that this largely may be a jobless recovery.

Even though many voters expected that the Obama economic program would provide immediate balm for the economy, Summers pointed out in his speech last week that the stimulus spending would peak not this year, but next year.In fact, only about 70 percent of the $789 billion in stimulus funds are slated to be spent by mid-2010. What this suggests is that America is a long way from knowing conclusively whether the boost from the stimulus spending will be large enough to lift the nation out of recession and bring down the unemployment rate before it hits, say, 11 percent.

The political danger for Obama is that if further stimulus spending is needed next year, there will not be a political constituency for it in the Congress or the country. A new USA Today/Gallup poll found that 59 percent of all voters and 66 percent of independents believe that Obama's entire domestic program "calls for too much spending." This number may reflect concerns about the cost of Obama's health care plan. But it also suggests that the economic lessons of John Maynard Keynes – that massive government spending is needed in deep recessions – has been lost on a sizable slice of the electorate.

Summers in no way argues that a second stimulus will be needed next year – even if there were the political will to pass one. But he does not flatly rule it out. When I asked him when the administration would know if the current stimulus is sufficient – or whether more legislation would be required – Summers replied, "It's too early to try to game out all the contingencies, all the possibilities, and all the ways the information could flow at this point. As the economy moves forward, we will have a more clear idea of where the economy is and what kind of growth trends are established."

The truth is that Obama and Co. may not get enough public credit for stabilizing the financial markets and staving off the Great Depression of the 21^st century. "In March the stock market was at the same level, after correcting for inflation, that it had been in 1966," Summers said in our interview. "I think we really were in a situation where we were quite close to the edge. Without the kinds of actions that the president took, it could have gone in a different way."

But while America narrowly avoided the abyss, the nation (despite the surging Dow) is still mired in a deep recession. And politically, Obama may be judged more on how quickly the jobs return than on whether he can steer health care reform through Congress.