State deficits and creeping pollyanna-ism, continued

I wanted to add a footnote to the grim reports about the state’s future general fund and unemployment insurance deficits I’ve posted here this week.

Any discussion of future revenues and deficits is bound to contain an obligatory qualifier. As Lee Nelson of DEED put it in talking about the projected unemployment insurance fund deficit, "If the economy gets a lot better, everything changes."

It’s a legitimate point. But at the Capitol these days, some people are trying to make a little too much of it. People like, oh, say, Gov. Tim Pawlenty and Minnesota Management and Budget Commissioner Tom Hanson (pictured). Here’s a bit of what they both had to say about the future fiscal outlook at Pawlenty’s June 16 press conference announcing unallotment cuts to the state budget (I’ve written a previous item that quotes TP at more length):

Pawlenty: "For the [2012-13 biennium], a lot will change between now and then. There’s still going to be a remaining gap, but economic circumstances will undoubtedly change…. [As to] the state’s outlook, if you were to make decisions now based on what you think you may know about the economy four years from now, you would be thrashing about in ways that I think would be very reckless, because you cannot–we cannot–predict what that looks like. These forecasts change by billions from year to year."

Hanson: "I think you’ve all heard me say this before. Two years ago, after the 2007 session, we had a $1 billion surplus for this biennium that’s going to start in ‘10 and ‘11. Things can flip fairly quickly. Two years ago, we thought we were going to have $1.1 billion. Now we’re still looking at $2.676 billion deficit."

You can see exactly what they were implying. If the economy surprised us by going south in a great big hurry, it might also surprise us by going back up in similar fashion. In that case, voila–problem largely solved.

Sadly, however, this is one of those cases where what sounds common-sensical is almost sure to prove not just false but silly. That’s because we’re talking about two very different sets of circumstances here: the pre- and post-financial crash performance of the general economy. As to the former, no reputable economist has ever suggested it was possible to predict the timing of the collapses that follow periods of asset inflation. Few ever see such crashes coming at all; caught up in the market hysteria that always feeds the growth of financial bubbles, they convince themselves gravity has been repealed and the growth will go on forever. Hence the shock of seeing a projected $1.1 billion surplus turn into a $5.9 billion deficit.

But there is a lot of historical evidence about the shape and trajectory of post-crash economies, and pleasant surprises tend to be in extremely short supply. Burdened by extraordinary levels of debt, much of it sunk into assets rendered suddenly worthless, economies sputter and falter for years to come. Credit stays scarce as overextended financial institutions hoard cash for their reserves. A frightened citizenry pulls in its horns and makes a sea change in its long-term spending-versus-savings patterns, thus compounding the problem of making the consumer economy start rolling again. GDP growth predictably languishes.

Japan experienced something similar following the collapse of a real-estate-and-stocks bubble there in the late 1980s, and handled the crisis with policies closely akin to those being pursued by the Obama administration now. The ensuing 10 years is now known to economists as Japan’s "lost decade," but the truth is that the Japanese economy to this day has not fully recovered.

Later this year, the National Bureau of Economic Research, which is responsible for calling the onset and conclusion of recessions, is likely to announce that the current downturn ended in the second or third quarter of ‘09. All this really means is that the economy will have stopped shrinking, at least temporarily, thanks to the impact of the federal stimulus package and the financial bailouts. But "recovery" is something else again. For months now, economists and market players have been steadily downgrading their predictions about post-recession U.S. growth prospects. A couple of weeks ago, one of the most influential Wall Street eminences–the CEO of bond-trading giant PIMCO–warned that the U.S. would have to make its peace with a "new normal": By a year from now, he said, "The market will realize that potential growth for the U.S. is no longer 3 percent, but is 2 percent or under."

A 2 percent growth rate, for the sake of reference, is about midway between America’s accustomed average of 3 percent growth and the 1.3 percent average annual rate of the 1930s. What’s more, most economists think all the debt in the system is likely to produce a more extreme version of the "jobless recovery" that followed the post-9/11 recession.

So when the see-no-evil set (which is not exclusively Republican, by any means) insists that we don’t know what the next few years hold, we should all try to remember the limits to the sense in which that’s true. We don’t know whether growth rates will be 1.8 or 2.1 or 2.4 percent–or, for that matter, whether they will even stay in positive-growth territory at all. And we can’t know exactly how big the resulting state deficits will be.

But we do know the chances that state revenues and state finances will return to a familiar range a year or three from now is practically nil. And it would be useful to stop pretending otherwise.