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America's economy in 2012 is like a plane flying at low altitude

Friday, forecasters expect the Labor Department to report the economy added 135,000 jobs in December, after gaining 200,000 in December. In 2012, weaker jobs gains are likely as consumer spending and economic activity slow.

Unemployment is expected to remain steady at 8.5 percent, as jobs creation barely keeps up with adult population growth. Over the past three years, the number of adults participating in the labor force—those employed, self employed, or unemployed but actively looking for work-- has declined significantly. Today, if the same percentage of adults was employed or seeking employment as when Barak Obama became president, the unemployment rate would be above 10 percent.

Adding adults on the sidelines, but who say they would reenter the labor market if conditions improved and part-time workers who would prefer full-time positions, the unemployment rate becomes 15.6 percent. Factoring in college graduates in low skill positions, like counterwork at Starbucks, and the unemployment rate is closer to 20 percent.

Without assertive efforts to address structural problems—huge trade deficits with China and on oil, and expensive and ineffective regulations in banking and health care—the country is headed for years of high youth unemployment and permanent displacement of many older workers. These conditions are not destiny—solutions are at hand but better leadership from the White House and more willingness to compromise in Congress are required to turn country around.

Too Little Economic Growth

Initial estimates indicate fourth quarter economic growth was a disappointing 2.8 percent and averaged only 1.7 percent for all of 2011. Stronger consumer spending, plus a surge in inventories and better home construction, pushed up fourth quarter growth.

In recent months, household spending outpaced income growth, debt piled up, and some pullback in consumer activity is now occurring. Unlike the years prior to the financial crisis, households are not be able to refinance credit card debt and auto loans by further mortgaging homes, and rising debt service will compel consumers to slow down in 2012.

Slower consumer spending indicates businesses will have trouble unloading unsold goods and inventory investments will slow in the first quarter. Together, slow consumer spending and inventory buildup will lower first quarter growth. A bit stronger housing construction and perhaps auto sales will help, but overall GDP will grow at about 2 percent or a bit less in the first quarter—hardly enough to inspire businesses to add more workers.

Much has been made of the need to rebuild household balance sheets—that requires working down credit card debt and mortgage balances. The former was largely completed last April. Now, household net worth and liquidity cannot improve much further without existing homes prices rising; however, those continue to decline or stagnate and millions of foreclosures will keep the market oversupplied for several years.

In 2012, residential construction will improve by about 10 percent over the previous year, because of demand for new apartment buildings—young folks are eschewing home ownership for fear of further declines in home values and resale problems if necessary to change jobs. Also, many unsold existing homes are far from cities, and demand for new homes is picking up closer to urban growth centers and jobs.

Jobs Outlook

The economy must grow at 2.5 to 3 percent—long term—to keep unemployment steady, because new technology and better methods permit labor productivity to increase 2 percent each year and natural population increases pushes up the labor force about 1 percent.

If conditions are mediocre and businesses cautious, productivity growth can slip—equipment and computers are kept beyond their economically useful life. Then unemployment can be kept steady with 2.5 percent growth or even 2 percent but that poses risks.

Many businesses remain reluctant to hire. They don’t expect a recession but are gearing for persistent subpar growth in the United States, slower growth in Asia and a recession in Europe. Many firms will meet modestly growing demand with smaller workforces—exploiting labor saving strategies to boost profits. Lower head counts could ignite a negative feedback cycle—fewer employees at enough firms would instigate lower spending and less demand for all firms and then layoffs would cascade.

The U.S. economy moving along at 2 or even 2.5 percent growth is like an airplane flying at low altitude. In a steady environment, the plane can keep going, but the slightest unexpected obstacle and the plane ditches. A tall obstacle may soon emerge in Europe or China, which both face formidable changes in 2012.

Overall, if the recovery is not derailed, continue to expect jobs growth of about 120,000 a month, and unemployment to gradually creep up to 9 percent by the middle of the year.

New Policies Needed

The economy must add 13.0 million jobs over the next three years—361,000 each month—to bring unemployment down to 6 percent. Factoring in continuing layoffs at state and local governments and federal spending cuts, the private sector must add about 380,000 jobs a month. To create that many jobs, GDP would have to increase at a 4 to 5 percent pace—that is possible after a long deep recession but for chronically weak demand for U.S. made goods and services.

Oil and trade with China account for nearly the entire $550 billion trade deficit, and dollars sent abroad to purchase oil and consumer goods from China that do not return to purchase U.S. exports are lost purchasing power. Consequently, the U.S. economy is expanding at about 2 to 2.5 percent a year instead of the 4 to 5 percent pace that is possible after a long and deep recession.

Without prompt efforts to produce more domestic oil, redress the trade imbalance with China and the rest of Asia, the U.S. economy cannot grow and create enough jobs.

Moreover, without curbing a Washington regulatory bureaucracy out of control and skyrocketing health care costs, the cost of doing business in America will remain too high and most new jobs will not pay wages high enough to stop the erosion in living standards for working Americans.

Peter Morici is a professor at the Smith School of Business, University of Maryland and former chief economist at the U.S. International Trade Commission. Follow him on Twitter@pmorici1

Peter Morici is an economist and professor at the Smith School of Business, University of Maryland, and widely published columnist. He is the five time winner of the MarketWatch best forecaster award. Follow him on Twitter @PMorici1.