The Postrecession Economy: What to Expect

As consumers scale back spending, can something else act as an engine of growth?

By Jerome Idaszak, Associate Editor, The Kiplinger Letter

September 28, 2009

Though it hurts now, consumers pulling back their spending is a good thing, restoring balance to the economy after a binge of credit-driven spending and a decade or more of chronic undersaving. There’s no question that the abrupt withdrawal is painful, exacerbating the depth and duration of the economic downturn. And the moderation of consumer spending spells a recovery plagued with pokey growth, paltry hiring and piddling wage gains.

In time, the change in behavior will mean a more stable economy, drawing its strength from multiple sources, and a return to healthier growth, less dependent on borrowed money. The share of gross domestic product (GDP) generated by consumer expenditures will return to the previous norm--the 66% to 68% slice it held before the dot-com boom in the late 1990s.

Turbocharged spending, fueled first by broad stock market gains and then by years of easy credit and a skyrocketing housing market, swelled the consumers’ share of GDP to about 71%. Now the recession, a plunge in home prices, rising unemployment, a credit freeze and scant wage gains are applying the brakes. Diane Swonk, chief economist with Mesirow Financial, says, “It’s not that consumers all of a sudden decide to become austere. They have no choice.”

What will take up the slack shed by consumers? Exports, for one. They’re likely to grow only about 5% in 2010, but are poised to take off after that as economies around the globe shake off the recession and begin to expand again. Aircraft, tech and financial services will all benefit.

Count on business spending to also pick up. By the second half of next year, look for firms to start buying equipment, bumping up capital investment by 1% for the year. While that’s mild, it’s a considerable improvement over the four straight quarters of contraction since mid-2008. What’s more, within a few years, as the overhang of office, retail and factory space is worked through, businesses will start to invest in construction as well, building new plants and office buildings.

Odds are it will take four or five years to make the adjustment. By about 2014, the engine of consumer growth will get an assist from these other smaller, but potentially powerful, locomotives. Growth of just 5% for exports and business investment--well within recent historical boundaries--would easily offset the loss of consumer steam power. A three percentage point drop in the personal consumption spending share of GDP amounts to about $420 billion today. Exports alone increased by $350 billion in the two-year period of 2006 and 2007.

In the meantime, the economic pace will be distinctly subpar. Mark Zandi, chief economist with Moody’sEconomy.com, says, “Growth will be slower and unemployment will be higher than was the case during much of the 1990s and earlier this decade.”

In the 12 months following a recession, GDP typically racks up a gain of about 6.5%. Not so this time. With unemployment remaining stubbornly above 9% through all of next year and consumers holding back--chalking up a mere 1.5% increase in spending--overall economic growth is likely to be less than half of the usual postrecession glow. We anticipate a gain of at best 3% in 2010.

For businesses, the absence of overheated consumers has a silver lining. Inflation will remain subdued. Measuring from Dec. to Dec., the Consumer Price Index should increase only about 2% in 2010 and won’t head much higher for a few years. In such a climate, stocks should do well, providing businesses with a favorable return on investment.

The one threat to the new balance: continuing increases in federal spending. Unless President Obama and Congress apply a brake, big deficits will lead to rising interest rates and higher inflation.

For weekly updates on topics to improve your business decisionmaking, click here.