Tackling the debt orgy's hangover

Saginaw, Michigan: Not long ago, if you wanted steak for lunch at the Texan Restaurant, less than two minutes drive from the Nexteer Automotive assembly plant, you had to be in the door by 11 o'clock in the morning. If you arrived any later, you joined a long line with other laggards and waited for a table to open up.

With noon fast approaching on a recent day, however, only a handful of customers sat in one of the restaurant's two sections and the other was closed.

Asked how the decline in the US auto industry has affected the local economy, Tammy Maynard, a waitress here since 1988, waved a hand around at the empty tables and said: "You're looking at it, sugar."

Regulars and retirees keep the restaurant in business, while workers at the nearby auto supplier plant buy steak at the beginning of the month when they get paid — if they come at all — and then dine on specials over the next four weeks.

"I just keep praying every day that we've hit the bottom and that things are going to get better," Maynard said, "because it doesn't seem like it could get any worse".

The US government may have bailed out General Motors, the country's largest automaker, but it has not begun to tackle the broader problems that led to the city's implosion. Doing so, experts say, would require the kind of political will that has not been in great evidence in the country recently.

To the few remaining auto workers left in a city half the size it was in 1960, the America they knew growing up is long gone and things can only get worse.

"We have made concession after concession on wages and benefits and there is no end in sight," said Dean Parm, a worker and union committeeman at Nexteer Automotive, whose hourly wages have been cut to around $17 (Dh62.52) an hour from $28. "It feels like we're dinosaurs. And we're on the verge of extinction."

Shrinking industry

This is the point of the story where many Americans typically glaze over because they see Michigan as a long-standing financial basket case of a state thanks to the shrinking US auto industry. But the problem is that the broad decline of the manufacturing sector that has been under way in this country for decades now may threaten not just the long-term health of the economy but also the living standards of all but the wealthiest Americans.

"The whole country is now seeing the story that Michigan has been living with for a long time," said Diane Swonk, chief economist at Mesirow Financial. "We have kicked the can so far down the road that now all we have is a cliff to fall off.

"The recession merely revealed a reality that has been with us for a long time. We faced a growing gap in education and skills that we tried to fill with debt and credit, which gave us the illusion of growth."

After Second World War, unskilled blue-collar jobs in manufacturing — typified and in many ways defined by the auto sector — became America's easy path to the middle class. As US manufacturing declined, starting in the 1980s Congress and successive administrations focused instead on the financial sector and relied on debt — its own and that of the US consumer — to foster economic growth.

At the same time, US companies faced a growing competitive challenge, largely from Asia — both in terms of manufacturing prowess and lower wages and legacy costs — that hastened the nation's exodus from the sector.

Trade imbalances

That in turn created lop-sided trade imbalances, with the US invariably in the red. The US trade deficit with China, for instance — a nation that tightly controls its imports — hit a record of $268 billion in 2008 a nd could reach $270 billion this year.

At the other end of the spectrum, deregulation and a laissez-faire attitude toward financial institutions culminated in the housing "boom" that former Ohio Attorney General Richard Cordray (who failed to win reelection in November) has aptly described as a "Roman orgy" of debt.

The subsequent downturn, the deepest and longest since the 1930s, merely exposed the extent of the hollowing out of America's manufacturing sector. By one estimate, since 2003 up to 20,000 manufacturing plants have shut down. The trend is leaving the country with a legion of unskilled workers stuck on long-term unemployment benefits.

"Over the past 20 years we have simply borrowed more money in order to prosper," said Bill Gross, co-chief investment officer of the world's biggest bond fund manager Pimco. "We forgot that the more stable and safe way to go is to make things.

"Now we're paying the price."

Turning a big ship

America now faces "structural" unemployment. Which means unless the world's largest economy changes in a fundamental way, millions of unskilled workers will remain jobless and economic growth will be sluggish, at best.

"The financial sector and America's wealthiest classes can help grow the economy, but not enough to bring down unemployment," said Harm Bandholz, chief US economist at UniCredit Research in New York.

None of this means a death spiral is inevitable. A growing number of economists and investors like PIMCO's Gross say a fix exists: a comprehensive overhaul of America's education system and retraining programmes for the unskilled.

Some point to the example of how Germany's manufacturing has rebounded a decade after the country was derided as the "sick man of Europe", though they add the German experience shows reform is a long, hard road.

America is now the "sick man of the globe", says John Silvia, chief economist at Wells Fargo. "The good news is the illness is not terminal."

But fixing America's education system for jobs of the future plus retraining unskilled workers would require bipartisan consensus, a long-term commitment by America's political class and funding to make it happen. In today's bitterly divided Washington, that is a tough sell.

In the recent midterm elections Democrats were pummeled less than two years after President Barack Obama's triumphal arrival in Washington and American voters remain in a volatile mood. Steven Schier, a politics professor at Carleton College in Minnesota, said unless the job mess is repaired more wild swings lie ahead.

"It's entirely possible we're going to see voters flip the switch every two years until both Republicans and Democrats get the message," he said.

Besides ensuring national paralysis, such swings would be bad for investors and financial markets, which abhor political risk. Peter Schiff of Euro Pacific Capital, who predicted the housing-fuelled crash (and made an unsuccessful bid for the US Senate this year), is among the sceptics who fear that Washington is not owning up to the problem.

Schiff said he favours ending long-term unemployment benefits because he says they prevent Americans from taking low-paid jobs.

Learning from the Germans

America could learn from the experience of Germany over the past decade.

By the time Germany passed its Agenda 2010 reform package in 2003, the country had been suffering from double-digit unemployment and mostly anaemic growth for a decade. The reforms included draconian cuts in pensions and unemployment benefits, increased labor flexibility and wage cuts.

Andreas Rees is UniCredit's chief German economist and says that the country's road to recovery from being the "sick man of Europe" has been anything but easy.

"The road to higher GDP growth was long and hard," he said. "It involved cutting wage costs for about 10 years and consumer expenditures have simply been a disaster."

"We've been through massive uncertainty and for many Germans it was a really painful period."

The reforms also resulted in the formation of the new Left socialist party, altering Germany's political landscape.

But thanks to the country's more flexible work force and "also partly good luck" in the form of demand from China for quality manufactured products, Rees said the "reforms have clearly paid off".

Driven by its manufacturing sector, the German economy is expected to grow by anywhere up to 3.7 per cent in 2010, while unemployment fell to an 18-year low of 7.5 per cent in October. Rees said he is upbeat about future consumer spending. But even seven years after reforms began, Rees said they are not over.

"The next step that the government was supposed to take was to improve the qualifications of the work force," he said.

"We have a serious lack of skilled workers, but now that things are looking alright German politicians do not appear to be in a hurry to follow through on this."

"This is not a positive development. But we have come a long way."