How Real Was the Prosperity?

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A trader checks out the Big Board during the wild ride on Jan. 23 Richard Drew/AP Photo

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Consumer Lending. The past 10 years will go down as one of the greatest consumer-lending sprees ever. Adjusted for inflation, consumer debt—including mortgages—rose an average 7.5% per year since 1997, far faster than the 4.2% rate of the previous 10 years. The last time debt rose so fast was the 1960s, as the postwar generation bought homes and autos. If Americans had kept borrowing at their pre-1997 pace, they would have had about $3 trillion less in debt.

The extra debt also represents a formidable obstacle for banks and other financial institutions that might want to lend more to consumers. "Going forward, we're not going to see this credit-driven growth," says Alistair Milne, a professor and banking expert at City University in London. "Banks are saying, 'we have to be more careful here.'"

Corporate Earnings. Yes, there's been a profit boom in recent years. Corporate earnings, as measured by government statisticians, have averaged 8% of GDP over the past decade, up from a low of 6.5% in the early '90s. That has helped propel stocks upward.

But here's an unfortunate truth—the profit surge has been mainly in one area, financial services. Financial institutions have benefited from the consumer credit boom, the proliferation of new financial instruments, and relatively low rates. By contrast, the earnings of nonfinancial companies over the past decade have averaged about 5.3% of GDP, about the same since the mid-1980s. There are few signs of any acceleration, even after years of restructuring.

The question now is how much of the gain in financial profits is sustainable and how much will simply evaporate once the credit binge is over. The problem: No one knows yet how badly the banks will be hit.

Productivity. Now we come to the trickiest area. The clearest sign of U.S. economic health has been growth in productivity, or output per hour worked. The faster productivity rises, the faster the economy grows without inflation, and the higher living standards go. Over the past 10 years, productivity, as measured by the Bureau of Labor Statistics, has grown at a 2.6% annual pace. That's up from a 1.6% annual rate over the previous decade. This extra point of productivity growth means the annual output of the U.S. economy is about $1 trillion higher than it would have been otherwise. Yet despite the higher output, U.S. consumers have taken on an extra $3 trillion in debt. This is a bit like someone who gets a raise, then goes and spends the money—and more—on a new car.

Some of those apparent productivity gains also may be illusory. If the economy was artificially boosted by excess borrowing, that would show up as higher output and, presumably, higher productivity. The implication is that once borrowing recedes to the historical average, actual underlying productivity growth might be lower than we thought.

The outcome won't become clear for a while. But if productivity growth is slower, then the economy's "speed limit"—the maximum growth rate that doesn't push up inflation—would be lower. Presumably, a slower-growing, less productive U.S. would become less attractive to foreign investors

The Stock Market and Global Growth. Investors probably have already taken into account the possibility of a mild U.S. recession. But the reason why the stock market hasn't fallen further—besides the Fed rate cuts—is the belief that the global economy will continue to grow, eventually helping multinational companies such as General Electric (GE).

But no one knows whether a U.S. consumer slowdown will undermine the world economy. It's unclear if Americans are more likely to cut back on imported LCD TVs or Starbucks (SBUX) coffee. The other question is the extent to which a consumer slump in the U.S. will affect business investment overseas. Factories are springing up in China and elsewhere to feed American demand. What if that demand falls?

These are sobering questions to consider. One consolation: The American economy can produce pleasant as well as nasty surprises. Many foresaw the tech bubble of the 1990s bursting; few predicted the housing boom that followed. Maybe a new force will emerge to propel the economy forward and keep spending robust. Right now, that's what everyone wants to know.

Mandel is chief economist for BusinessWeek .