Paul Krugman takes on the question of how we get the economy to re-balance itself for a post-bubble environment and comes up with the disturbing answer that he doesn’t really know:
To be more specific: the severe housing slump we’re experiencing now will end eventually, but the immense Bush-era housing boom won’t be repeated. Consumers will eventually regain some of their confidence, but they won’t spend the way they did in 2005-2007, when many people were using their houses as ATMs, and the savings rate dropped nearly to zero. [...]
A more plausible route to sustained recovery would be a drastic reduction in the U.S. trade deficit, which soared at the same time the housing bubble was inflating. By selling more to other countries and spending more of our own income on U.S.-produced goods, we could get to full employment without a boom in either consumption or investment spending. [...]
Furthermore, even if the dollar falls again, where will the capacity for a surge in exports and import-competing production come from? Despite rising trade in services, most world trade is still in goods, especially manufactured goods — and the U.S. manufacturing sector, after years of neglect in favor of real estate and the financial industry, has a lot of catching up to do.
Anyway, the rest of the world may not be ready to handle a drastically smaller U.S. trade deficit. As my colleague Tom Friedman recently pointed out, much of China’s economy in particular is built around exporting to America, and will have a hard time switching to other occupations.
Krugman says we may need a prolonged period of government intervention in the economy even past what’s needed as a short-term stimulus. I would say that part of the answer may well involve taking a larger share of our productivity gains as increased leisure rather than increased production and incomes. As noted below, Americans on average put in many more hours of work than do the citizens of most other wealthy countries. A structural shift to less-work, less-output dynamic could be catastrophic if that means a structural shift to a very high rate of unemployment. But if it means a structural shift toward six-week vacations and fewer 60 hour weeks then that could be a good thing.