The economy nosedived in the 2008 downturn and the newly revised peak-to-trough decline in GDP is now estimated at 4.1% — the steepest contraction since the 1930s. Given the extent of the decline, we should have seen a much greater “rubber-ball bounce” but we didn’t — and the amount of policy stimulus a decade ago and two decades ago pales next to the massive doses of fiscal and monetary relief dished out this time around. By now, if this was a normal recession followed by a normal recovery, as opposed to a debt-deleveraging-depression, real GDP would already be back at a new high. But here we are, 31 months after the recession began, and the level of real GDP is still -1.1% below its prior high.

There are two other critical factors preventing NBER from declaring the all-clear signal.

First, despite the dramatic rebound in the equity market in 2009, personal income fell in 49 of the 52 U.S. cities of a million population or more. The three cities that saw an increase were closely tied to the federal government (like Washington D.C.). Indeed, government pay managed to rise 2.6% last year while all the suckers that work in the private sector posted a 6% wage decline. How this doesn’t breed dissent is a legitimate question.

Second (…)  is the rapid decline in the employment-to-population ratio. This is a far more informative measure regarding labour market performance than the traditional unemployment rate, especially at a time when discouraged workers are withdrawing from the labour force at such an alarming clip.

The employment rate has declined now for three months in a row, back to where it was at the start of the year, and smartalecks who see this recovery as anything but disturbing don’t realize that this employment rate, at 58.4%, is down from 64.0% at the 2007 high. This was the largest drop in the post-war era and what it means is that the economy is 12 million jobs shy of being at full employment.

Instead of declaring an outright war on unemployment, we instead have a government bent on measures to boost spending on cars and homes that nobody really wants since, at the margin, all people want to do is boost their once-depleted savings rates and get out of debt; or at least a half dozen housing plans to help distressed mortgage borrowers. Or infrastructure spending that so far seems to have helped line the pockets of public sector union officials with no obvious payback in terms of job creation. At least FDR paid people to work, even if it meant skyscrapers, bridges, monuments and national parks. They didn’t get paid do sit idle for 99 weeks so they can then drop out of the labour force and into oblivion (almost 45% of the unemployed have been so for more than 26 weeks — in no other recession in the past six decades did this share ever cross above 26%).

Almost half of the ranks of the unemployed have been looking for a job fruitlessly for at least six months. Let’s get these people re-engaged in the labour market, get them re-tooled and retrained for the skill set that businesses need now and in the future. Give these folks a shovel from 8 to 12 and engineering courses from 1 to 5 in return for their jobless insurance check. It’s time to get creative and aggressive with minimal cost to the taxpayer. If we can win this fight against unemployment, it’s amazing what other positive things will fall into place, from housing demand to government revenues to consumer credit quality.

The Economy Needs a Bit of Ingenuity

By EDMUND S. PHELPS

THE steps being taken by government officials to help the economy are based on a faulty premise. The diagnosis is that the economy is “constrained” by a deficiency of aggregate demand, the total demand for American goods and services. The officials’ prescription is to stimulate that demand, for as long as it takes, to facilitate the recovery of an otherwise undamaged economy — as if the task were to help an uninjured skater get up after a bad fall.

The prescription will fail because the diagnosis is wrong. There are no symptoms of deficient demand, like deflation, and no signs of anything like a huge liquidity shortage that could cause a deficiency. Rather, our economy is damaged by deep structural faults that no stimulus package will address — our skater has broken some bones and needs real attention.

The good news is that some of the damage done in the past decade will heal. The pessimism that broke out in 2009 is dissipating. The oversupply of houses and office space, which is depressing construction, will wear off. Banks and households are saving quickly enough to retire most of their excessive debt within a decade.

But other problems are not self-healing. In established businesses, short-termism has become rampant. Executives avoid farsighted projects, no matter how promising, out of a concern that lower short-term profits will cause share prices to drop. Mutual fund managers threaten to dump shares of companies that miss quarterly earnings targets. Timid and complacent, our big companies are showing the same tendencies that turned traditional utilities into dinosaurs.

Meanwhile, many of the factors that have long driven American innovation have dried up. Droves of investors, disappointed by their returns, have abandoned the venture capital firms of Silicon Valley. At pharmaceutical companies, computer-driven research is making fewer discoveries than intuitive chemists once did. We cannot simply assume that, when the recession ends, American dynamism will snap back in place.

Many pin their hopes for reviving the economy on gains in worker productivity. But such workplace advances often destroy more jobs than they create. That happened in the Great Depression, when increased worker productivity allowed companies and the economy to expand without creating new jobs.

The decline in American dynamism is not the only problem. It has been accompanied by a decline of what I call inclusion. Not only were low-wage workers largely cut out of the economic gains of the 1990s and 2000s — much of the middle class was, too. In part, this is because the emerging economies around the globe have ended our competitive advantage in manufacturing, and jobs have fled. We can’t compete in those industries any more, and our business sector has not yet found new advantages.

The worst effect of focusing on supposedly deficient demand is that it lulls us into failing to “think structural” in dealing with long-term problems. To achieve a full recovery, we have to understand the framework on which our broad prosperity has always been based.

First, high employment depends on a high level of investment activity — business expenditures on tangibles like offices and equipment, and also training for new or existing employees, and development of new products.

Sustained business investment, in turn, rests on innovation. Business cannot wait for discoveries in science or the rare successes in state-run labs. Without cutting-edge products and business methods, rates of return on a great many investments will sag. Furthermore, innovation creates jobs across the economy, for entrepreneurs, marketers and buyers. State-led technology projects do not.

High business investment also depends on companies having confidence in the future. A company might be afraid to invest in research or product lines if it fears the rest of the economy is not doing the same — or if it fears the government might become hostile to its goals. During the Depression, John Maynard Keynes warned President Franklin D. Roosevelt not to damage business confidence with anti-profit rhetoric — to treat titans of business “not as wolves or tigers, but as domestic animals by nature.”

What, then, is to be done? One reform would be to create a First National Bank of Innovation — a state-sponsored network of merchant banks that invest in and lend to innovative projects. Another would be to improve corporate governance by tying executives’ compensation to long-term performance rather than one-year profits, and by linking fund managers’ pay to skill in picking stocks, not in marketing their funds. Exempting start-ups from corporate income tax for a time would also help.

We also need a program of tax credits for companies for employing low-wage workers. That may seem counterintuitive at a time when the Obama administration is pressing education and high-paying jobs, but we need to create jobs at all levels. Early last year, Singapore began giving such credits — worth several billion dollars — and staved off a recession. Unemployment there is around 3 percent.

A revamp of the economy for greater dynamism and inclusion is essential for prosperity and growth. Rather than continuing to argue over solutions to a problem we do not have — low demand — the country needs to focus on fixing the structural problems that, unresolved, will stymie the economy over the long haul.