CAMBRIDGE - America's presidential election is now just six months away. If history is a reliable guide, the outcome will depend significantly on the economy's performance between now and November 6, and on Americans' perception of their economic future under the two candidates.
At the moment, America's economy is limping along with slow growth and high unemployment. Output grew by just 1.5 per cent last year, and real GDP per capita is lower now than before the economic downturn began at the end of 2007. Although annual GDP growth was 3 per cent in the fourth quarter of 2011, more than half of that reflected inventory accumulation. Final sales to households, businesses, and foreign buyers rose at only a 1.1 per cent annual rate, even slower than earlier in the year. And the preliminary estimate for annual GDP growth in the first quarter of 2012 was a disappointing 2.2 per cent, with only a 1.6 per cent rise in final sales.
The labour market has been similarly disappointing. The March unemployment rate of 8.2 per cent was nearly three percentage points above what most economists would consider a desirable and sustainable long-run level rate. Although the rate was down from 9 per cent a year ago, about half of the change reflected a rise in the number of people who have stopped looking for work, rather than an increase in job creation and the employment rate.
Indeed, the official unemployment rate understates the weakness of the labour market. An estimated 6 per cent of all employees are working fewer hours per week than they would like, and about 2 per cent of potential employees are not counted as unemployed because they have not looked for work in the past few weeks, even though they would like to work. Adding these individuals to those officially classified as unemployed implies that about 15 per cent of potential labour-force participants are working less than they want.
Solid increases in payroll employment at the start of the year contributed to a general sense of confidence. But the rate of increase in payroll employment fell in March to less than half of the rate recorded in previous months, and the number of workers claiming unemployment benefits recently jumped to a four-month high.
Even those who are working are seeing their incomes shrink. Real average weekly earnings have fallen in recent months, and are now lower than they were 18 months ago. The broader measure of real per capita after-tax personal income has also been falling, and is back to levels last seen a year ago.
Despite their declining incomes, households raised their spending in early 2012 at a rapid pace by cutting their saving rate to just 3.7 per cent. Without further declines in the saving rate from this very low level, consumer spending will not continue to grow as robustly. Recent reports of declining consumer confidence reinforce the likelihood that spending will slow in the months ahead.
Moreover, the housing market remains in bad shape. The most reliable index of comparable house prices has continued to decline month after month, and prices are now about 7 per cent lower in real terms than a year ago, implying a US$1 trillion loss of household wealth. With roughly 25 per cent of all homeowners with mortgages owing more than their homes are worth, the decline in house prices reflects high rates of default and foreclosure. Falling prices, together with stricter lending standards, has spurred a shift by would-be home buyers to the rental market, causing recent declines in the sales of both new and existing homes.
The weakness of America's economy is not limited to the household sector. Industrial production has been unchanged for the past two months, and utilisation of industrial capacity has declined. And the monthly purchasing surveys conducted by the Institute for Supply Management now indicate weaker activity among service firms as well.
Looking ahead, strong headwinds imply that it will be difficult to achieve better economic performance in the rest of the year. Higher energy prices are reducing real household spending on non-energy goods and services; weakness in Europe and Asia will hurt America's exports; state and local governments are cutting their spending; and concerns about higher taxes in 2013 will dampen both business investment and big-ticket consumer spending.
The economy is thus shaping up to be a serious liability for President Barack Obama, who is likely to place the blame on the conditions that he inherited from President George W. Bush, and on the Republican majority in the House of Representatives. But the public is likely to place the blame on the president, and surveys indicate that a growing number of Americans believe that Mitt Romney, the almost certain Republican candidate, would do a better job than Obama at managing the economy.
The polls are very close, and voters have not yet locked in their decisions. The economy could rise more sharply than expected in the months ahead. If not, Obama will try to shift attention from the overall economy by emphasizing his plan to raise taxes on high-income individuals. And a variety of other issues, including immigration and the role of women, might influence voters.
But the state of the economy is usually the most important determinant of who wins national elections in the United States. And US economic conditions now favour Romney.
Martin Feldstein, Professor of Economics at Harvard, was Chairman of President Ronald Reagan's Council of Economic Advisers and is a former president of the US National Bureau for Economic Research.