RECOVERY DEPENDS ON MAIN STREET / THE FINANCIAL TIMES COMMENTARY & ANALYSIS ( VERY HIGHLY RECOMMENDED READING - A MUST READ )

Recovery depends on Main Street

By Robert Reich

Published: March 23 2010 22:30

Can the American economy recover if only its big global companies, Wall Street and high-income Americans are doing better but its small businesses and middle and lower-income Americans are not? The short answer is no.

The earnings of companies in the Standard & Poor’s 500 stock index tripled in the fourth quarter, but this does not mean the rest of the US economy is doing well. Much of their sales were into fast-growing markets in places like India, China and Brazil. Meanwhile, they continued to slash jobs and cut costs at home.

Alcoa, for example, had $1.5bn in cash at the end of 2009, double what it had on hand at the end of 2008. Sounds terrific until you realise how it did it. By cutting 28,000 jobs – 32 per cent of its workforce – and slashing capital expenditures 43 per cent.

Nor does the fact that big US companies have lots of cash signal a broader recovery. The S&P 500 are now holding $932bn in cash and short-term investments and can borrow cheaply. So far in 2010, big US corporations have issued $195.2bn of debt, excluding government-guaranteed bonds. But this cash is not going into new investment. Much is being used to buy other companies, which usually leads to more job losses.

Much of the rest is being used to buy back their own stock in order to boost their share prices. There were 62 such buy-backs in February, valued at $40.1bn – the biggest share buy-back since September 2008. The major beneficiaries are shareholders, including top executives, whose pay is linked to share prices. But the buy-backs do nothing for most Americans.

None of this is stopping supply-side fanatics from arguing government needs to cut taxes on big corporations to spur the recovery. Their argument is absurd. Big companies do not know what to do with all the cash they have as it is. They are not investing it in new plant or jobs. So why should the government cut their taxes and enlarge their cash hoards even more?

The picture on Main Street is the opposite. Small businesses are not selling much because they have to rely on American consumers and Americans still are not buying much.

Small businesses are also finding it hard to get credit. In a credit survey in February from the National Federation of Independent Businesses, only 34 per cent of small businesses reported normal and adequate access to credit. Not incidentally, the NFIB’s Small Business Optimism Index fell 1.3 points last month.

While big companies are finding it easy to borrow in the bond markets, smaller companies depend on bank credit, whose supply remains limited. Last year, total bank lending fell 7.4 per cent, the biggest decline in almost 60 years, and there is no sign of a turnround. To the contrary, a rising number of commercial loans are going bad. Banks still face further losses on mortgages and commercial loans so lack the reserves to increase lending.

This is a problem because companies with fewer than 100 employees accounted for almost half of net job growth during the last two recoveries, according to the US Labor Department’s Bureau of Labor Statistics.

No wonder, then, American consumers are shedding their debts like mad. Total US household debt, including mortgages and credit card balances, fell 1.7 per cent last year – the first drop since the government began recording consumer debt in 1945. Much of the debt-shedding has been through default – consumers simply not repaying and walking away from homes and big-ticket purchases.

Optimists say the defaults are leaving many people with more cash to spend and save. But that rosy view disregards how much debt US consumers still bear. As of the end of 2009, debt averaged $43,874 per American, or about 122 per cent of annual disposable income. Most analysts think a sustainable debt load is around 100 per cent of disposable income – assuming a normal level of employment and access to credit. Yet unemployment is still sky-high and it is becoming harder for most people to get new mortgages and credit cards. With housing prices still in the doldrums, they cannot refinance their homes or take out new loans on them. The days of homes as ATMs are over.

Optimists also point to rising stock prices that supposedly make consumers feel wealthier. But the net worth of most Americans is tied up in their homes, which are worth less than in 2007. The “wealth effect” is relevant to the richest 10 per cent of Americans whose net worth is mostly in stocks and bonds. The top 10 per cent accounted for about half of total national income in 2007, but they represent only 40 per cent of total spending. A sustainable recovery cannot be based on the top 10 per cent.

Unemployment or fear of it continues to haunt the population. That is a major reason consumer confidence is still dropping. There is also the extra need to save as boomers face retirement. Given all this, it is sensible for Americans to continue holding back from the malls, but this means a painfully slow recovery. American consumers account for 70 per cent of the total demand for goods and services in the US economy, and a sizeable chunk of world demand.

The economy shows signs of improvement largely because the government is spending huge sums and the Fed is essentially printing even more money. But where will demand come from when the stimulus is over and the Fed tightens? That question hangs over the economy like a dense cloud. Until there is an answer, a sustainable recovery for any other than America’s largest corporations, Wall Street and the wealthy is a mirage.

The writer, a former US labour secretary, is professor of public policy at the University of California at Berkeley. His latest book is Supercapitalism

Copyright The Financial Times Limited 2010