The new normal

The new normal
The business landscape has changed fundamentally; tomorrow’s environment will be different, but no less rich in possibilities for those who are prepared.

March 2009 • Ian Davis

Source: Strategy Practice

This short essay by McKinsey’s worldwide managing director, Ian Davis, is a Conversation Starter, one in a series of invited opinions on topical issues. Read the original essay, then see what readers had to say.

It is increasingly clear that the current downturn is fundamentally different from recessions of recent decades. We are experiencing not merely another turn of the business cycle, but a restructuring of the economic order.

For some organizations, near-term survival is the only agenda item. Others are peering through the fog of uncertainty, thinking about how to position themselves once the crisis has passed and things return to normal. The question is, “What will normal look like?” While no one can say how long the crisis will last, what we find on the other side will not look like the normal of recent years. The new normal will be shaped by a confluence of powerful forces—some arising directly from the financial crisis and some that were at work long before it began.

Obviously, there will be significantly less financial leverage in the system. But it is important to realize that the rise in leverage leading up to the crisis had two sources. The first was a legitimate increase in debt due to financial innovation—new instruments and ways of doing business that reduced risk and added value to the economy. The second was a credit bubble fueled by misaligned incentives, irresponsible risk taking, lax oversight, and fraud. Where the former ends and the latter begins is the multitrillion dollar question, but it is clear that the future will reveal significantly lower levels of leverage (and higher prices for risk) than we had come to expect. Business models that rely on high leverage will suffer reduced returns. Companies that boost returns to equity the old fashioned way—through real productivity gains—will be rewarded.

Another defining feature of the new normal will be an expanded role for government. In the 1930s, during the Great Depression, the Roosevelt administration permanently redefined the role of government in the US financial system. All signs point to an equally significant regulatory restructuring to come. Some will welcome this, on the grounds that modernization of the regulatory system was clearly overdue. Others will view the changes as unwanted political interference. Either way, the reality is that around the world governments will be calling the shots in sectors (such as debt insurance) that were once only lightly regulated. They will also be demanding new levels of transparency and disclosure for investment vehicles such as hedge funds and getting involved in decisions that were once the sole province of corporate boards, including executive compensation.

While the financial-services industry will be most directly affected, the impact of government’s increased role will be widespread: there is a risk of a new era of financial protectionism. A good outcome of the crisis would be greater global financial coordination and transparency. A bad outcome would be protectionist policies that make it harder for companies to move capital to the most productive places and that dampen economic growth, particularly in the developing world. Companies need to prepare for such an eventuality—even as they work to avert it.

These two forces—less leverage and more government—arise directly from the financial crisis, but there are others that were already at work and that have been strengthened by recent events. For example, it was clear before the crisis began that US consumption could not continue to be the engine for global growth. Consumption depends on income growth, and US income growth since 1985 had been boosted by a series of one-time factors—such as the entry of women into the workforce, an increase in the number of college graduates—that have now played themselves out. Moreover, although the peak spending years of the baby boom generation helped boost consumption in the ’80s and ’90s, as boomers age and begin to live off of retirement savings that were too small even before housing and stock market wealth evaporated, consumption levels will fall.

Companies seeking high rates of income and consumption growth will increasingly look to Asia. The fundamental drivers of Asian growth—productivity gains, technology adoption, and cultural and institutional changes—did not halt as a result of the 1997 Asian financial crisis. And Asian economies—though they have rapidly deteriorated in recent months—are unlikely to be stopped by this one. The big unknown is whether the temptation to blame Western-style capitalism for current troubles will lead to backlash and self-destructive policies. If this can be avoided, the world’s economic center of gravity will continue to shift eastward.

Through it all, technological innovation will continue, and the value of increasing human knowledge will remain undiminished. For talented contrarians and technologists, the next few years may prove especially fruitful as investors looking for high-risk, high-reward opportunities shift their attention from financial engineering to genetic engineering, software, and clean energy.

This much is certain: when we finally enter into the post-crisis period, the business and economic context will not have returned to its pre-crisis state. Executives preparing their organizations to succeed in the new normal must focus on what has changed and what remains basically the same for their customers, companies, and industries. The result will be an environment that, while different from the past, is no less rich in possibilities for those who are prepared.

Jobless and Staying That Way


Americans have almost always taken growth for granted. Recessions kick in, financial crises erupt, yet these events have generally been thought of as the exception, a temporary departure from an otherwise steady upward progression.

But as expectations for the recovery diminish daily and joblessness shows no sign of easing — as the jobs report on Friday showed — a different view is taking hold. And with it, comes implications for policymaking.

The “new normal,” as it has come to be called on Wall Street, academia and CNBC, envisions an economy in which growth is too slow to bring down the unemployment rate, while the government is forced to intervene ever more forcefully in a struggling private sector. Stocks and bonds yield paltry returns, with better opportunities available for investors overseas.

If that sounds like the last three years, it should. Bill Gross and Mohamed El-Erian, who run the world’s largest bond fund, Pimco, and coined the phrase in this context, think the new normal has already begun and will last at least another three to five years.

The new normal challenges the optimism that’s been at the root of American success for decades, if not centuries. And if it is here, the new normal could force Democrats and Republicans to rethink their traditional approach to unemployment and other social problems.

Some unusual suspects, like Glenn Hubbard, dean of the Columbia Graduate School of Business and an economic adviser to George W. Bush, are talking about a new, expanded role for the government in addressing the problem. In particular, Mr. Hubbard favors investing more in education to retrain workers whose jobs are never coming back. “If there is a new normal, it’s more about the labor market than G.D.P.,” he said. “We have to help people face a new world.”

For his part, Mr. Gross, also a free-market advocate, believes that it’s time for the government to spend tens of billions on new infrastructure projects to put people to work and stimulate demand.

After the recession and the financial crisis, Mr. Gross came around to the view that something structural in the economy had been altered and that the debt-fueled boom led by consumers over the past two decades was over.

Last week only provided more ammunition for his argument. On Tuesday, Treasury Secretary Timothy Geithner warned that unemployment could go up before it goes down, and on Friday, the jobs report showed that the economy lost 131,000 jobs last month.

Nearly half the 14.6 million unemployed have been out of work for more than six months, a level not seen since the Depression. That’s especially worrisome because the longer unemployment persists, the more skills erode and the harder it becomes to find work.

White House officials, like Christina Romer, a top economic adviser to President Obama, have been busy speaking out against the idea of a new normal. “The fundamental problem we are still facing is the old cyclical, not the new normal,” she said. “What you need to do to get back to normal is to find more ways to get demand up.”

But the new-normal concept is gaining ground. “There is no way to know for sure, but there are broad reasons to think the new normal is possible,” said Greg Mankiw, an economist who advised President George W. Bush and now teaches at Harvard. “We’ve had a deep recession that’s lingering for quite a while, and the question is: Will it leave persistent scars?”

Laura Tyson, chief economic adviser to President Clinton, counts herself firmly in the new-normal camp: “I think we’re going to have slower growth, a higher household savings rate and an elevated unemployment rate for several years.”

Of course, one month’s data is hardly conclusive. And highs and lows in the economy have always been punctuated by the observation that this time is different. But more evidence is emerging that the old normal of unemployment at about 5 percent during buoyant economic growth is over.

Not only are more people out of work longer, but their options are narrowing. Roughly 1.4 million people have been jobless for more than 99 weeks, the point at which unemployment benefits run out. “The situation is devastating,” said Robert Gordon, an economics professor at Northwestern and an expert on the labor market. “We are legitimately beginning to draw analogies to the Great Depression, in the sense that there is a growing hopelessness among job seekers.”

Professor Gordon doesn’t foresee a quick turnaround. But the Obama administration predicts that unemployment will drop to 8.7 percent by the end of next year, and eventually sink to 6.8 percent by the end of 2013.

To reach that level, the economy would have to add nearly 300,000 workers a month over the next three years, according to Peter Morici, a business professor at the University of Maryland. Even in the first half of the year, when the economy grew at a healthy 3 percent, it added fewer than 100,000 jobs a month.

The problem is that the American safety net, which has been looser than those in Europe, was built on the assumption that unemployment would be short term. As a result, a rethinking is in order, said Mr. Hubbard, whose new book, “Seeds of Destruction: Why the Path to Economic Ruin Runs Through Washington, and How to Reclaim American Prosperity,” is coming out this month.

The current approach, with its focus on payments over a relatively short period of time, he said, “came out of the world where unemployment was relatively temporary and then you went back to a similar position.”

“That isn’t what’s happening today.”

While he doesn’t favor extending benefits, Mr. Hubbard supports more government spending on job training as well as help for community colleges to reverse the erosion of jobs skills among the long-term unemployed.

Mr. Gross is more expansive. “We think the coma will last for years unless government policy changes to restimulate the private sector and bring unemployment down,” he said. He wants Washington to invest billions on infrastructure improvements and clean energy, along with the expanded job training favored by Mr. Hubbard.

Despite his long-held belief in free markets, smaller government and lower taxes, Mr. Gross said politicians must recognize that this time, “government is part of the solution.” He added, “In the new-normal world, there are structural problems, which require structural solutions.”

Vintage Essays, ‘fear’ ~Judy Williamson

Dear Readers,

When we understand how our minds work, we can then begin to apply this understanding to improving our life’s circumstances. By knowing that simultaneously faith and fear cannot co-exist in our thoughts, we then realize that we can decide to be either fearful or faithful. The choice is ours. Also, when we begin to recall occurrences in our personal history wherein we either succeeded or failed, we drag along all the corresponding memories deposited in our sub-conscious mind that trail these memories like a pack of starving wolves. And, as the story goes, we decide which memory predisposes us to our future rewards or penalties by deciding which wolf to feed.

In simple terms, we create our outcomes by the thoughts that we choose to focus on with regularity. When we notice ourselves in a downward spiral due to the negative preponderance of thoughts, we can reverse our decline by deciding to focus instead on things positive. This may sound overly optimistic, but if we make a firm decision to do it with regularity, we will notice that we have turned the tide by turning our thoughts around. Fears that are focused on become more than nightmares because they also control our waking hours and even seep into our daydreams. Fear can stop us in our tracks, but faith can open wide the path that needs to be traveled. By being faithful, we cannot be fearful.

I remember a story from the parenting course that I used to teach. It went something like this:

A mother was encouraging her little boy to step outside the front door and bring in the milk that was delivered earlier by the milkman. But, it was dark outside, and the little boy was frightened by the lack of daylight. His mother, trying to reason with him, said: “Tim, don’t be afraid, God is out there watching and you will be safe.” Not convinced, Tim responds, “Well, if God is out there, have him bring in the milk!”
We chuckle at the story, but yet we are often guilty of the same response. Instead of boldly stepping across the threshold to get the milk, we wait and see what will happen if we don’t. Soon we learn that fears can only be conquered by doing the thing we fear the most. There is no substitute for our own action. Success is not experienced vicariously, but in real time – our real time. So, step on board the success train, and face the fear that holds you back. You can only be your very best if you refuse to accept whatever is metaphorically holding you back. Don’t ask someone to do what you are not capable of doing yourself. Rather, step outside the door and bring home the milk!

Be Your Very Best Always,

Judy Williamson