ARCHIVES :: NOVEMBER 2002 :: COVER STORY

UNITED WE
$PEND

Consumers Saved
The Economy After 9/11.
Can They Keep On Shopping?

Illustration: Gene Greif

By GREG IP and RUSSELL GOLD
Staff Reporters of The Wall Street Journal

Immediately after Sept. 11, it looked as if the U.S. economy might buckle. Americans prepared for war, the stock market plunged, and business investment, already weak, slumped further.

But it turns out the terrorist assaults marked the ending phase of a recession, not a spike. How? Consumers such as Christine Grable in Austin, Texas, kept buying.

In the wake of Sept. 11, Mrs. Grable and her then-fiance cut back on fancy restaurant meals, concerts and what she calls “joy spending.” But their somber mood faded quickly. The couple bought a house in April and jetted off for a Hawaiian honeymoon the following month. Though her employer, Dell Computer, was shedding jobs, Mrs. Grable felt confident she would keep hers—and she has. “It was kind of, jump now and think later,” she says.

If Sept. 11 seemed to signal the American way of life was under attack, American-style spending seemed the proper response. “The American economy will be open for business,” President Bush assured the nation the evening of Sept. 11. General Motors, kicking off a campaign of no-interest financing on new cars, urged consumers to “Keep America rolling.”

They did—and have continued to do so in the year or so since.

The vital question now is whether consumers—whose spending accounts for two-thirds of all U.S. economic activity—will continue shelling out for cars, appliances, furniture and services. As businesses remain reluctant to increase their expenditures, and economic trouble abroad endangers U.S. exports, consumers are more critical than usual to the economy.

Last fall, consumer purchases saved the U.S. economy from deep recession. The Federal Reserve played a big role by cutting short-term interest rates to a 41-year low. So did the Bush administration and Congress, with a tax cut that began last summer with $300 rebate checks and continued with reduced tax withholdings earlier this year. Auto makers and retailers helped with sharp discounts.

But none of that would have been sufficient if consumers hadn’t continued to spend liberally. “We had an event with a powerful psychological impact, with the potential to really cut into consumer spending at a time the economy was already weak,” says Laurence Meyer, a former Federal Reserve governor. “It’s very surprising it had such little impact on the consumer. Maybe it really is true: We love to shop.”

Paychecks Over Paranoia

 What explains Americans’ willingness to keep spending? Why weren’t people as distracted as they were when Iraq invaded Kuwait back in 1990, setting the stage for the Gulf War and a U.S. recession?

One factor was the burst of patriotism in response to the attacks, along with quick successes in Afghanistan and the drop in oil prices. But that doesn’t explain the entire mystery. Simple economic calculations have also been at work. Over the past year, Americans have sized up their financial situations, and they liked what they saw. Paychecks proved more important than paranoia.

Take-home pay has risen. Mortgage rates have tumbled. Inflation has been tame. Although unemployment has risen, it remained lower than it had been for most of the 1990s and 1980s. The stock market plunge caused many people to rethink their retirement dreams. But for a lot of people, stock losses were offset by the rising value of their biggest asset: their homes. Surveys find consumers more optimistic about their financial future now than at all but a handful of occasions in the past three decades.

But with the anniversary of the Sept. 11 attacks now past, the vitality of consumer spending is once again in question. A wave of corporate scandals has pummeled the stock market, wiping out more wealth and, in some ways, shaking Americans’ faith in the nation’s institutions more than the terrorist attacks did.

Pessimists argue that if the economy goes through a prolonged period of slow growth, then rising unemployment, stagnant wealth and weak income growth could erode the optimism. In that case, the higher debts that have financed much of the recent spending will be harder to support. (Related article on Page 13) Recent economic data show that retail sales fell significantly in September, because of a sharp drop in auto sales, and that consumer confidence has eroded to its lowest levels in nine years, amid stock market declines and talk of war.  

But even if consumers slow their spending for a while to rebuild savings, a jarring collapse of consumer spending seems unlikely—unless the U.S. economy suffers another devastating blow. Over the course of the recession, which began in March 2001 and appears to have ended in December, inflation-adjusted consumer spending grew at an annual rate of 3.2%, better than in any of the previous five recessions. This year, consumption has accelerated to an annual rate of nearly 4%. Without the burst of spending that followed the attacks, the recession would have lasted longer, and the unemployment rate would have risen higher.

Purchasing Power

 The most important factor in consumers’ buy-now, worry-later attitude was continued gains in their purchasing power. In most downturns and the periods that immediately follow them, layoffs and deferred raises limit household incomes and consumers’ ability to spend. This time, aftertax incomes eked out a small gain during the recession and then rose strongly afterward.

The Bush tax cut accounted for some of that increase. But consumers also benefited from a more permanent economic change: Gains in productivity growth. With workers producing more for each hour they work, companies can pay higher wages without raising prices for their products. That helps explain the steady decline in inflation to its lowest levels since the 1960s. Consumers see it at the cash register, as Wal-Mart, Costco, Target and other discounters have used their buying clout and efficient inventory management to hold down prices.

Not only have businesses marked down prices, but they have offered imaginative promotions that many consumers couldn’t pass up.

Steve Ward, an assistant district attorney in Charlotte, N.C., could have held off on a new car. But his local Volvo dealer offered two free airline tickets if he picked up the car in Europe. By dealing directly with the factory, he saved about $3,000 in markups that normally would have been charged for importing that vehicle. “They dangled that carrot out there and I bit on it,” says Mr. Ward, who used the money he saved for a two-week European vacation. To prepare for the trip, he spent more than $300 here at home, including $120 for a new suitcase.

Even rising unemployment didn’t shake consumers as much as in past recessions. The unemployment rate has climbed from a 30-year low of 3.6% in 2000 to 6% now, but it’s still lower than it was during the growth years of the 1980s and early part of the 1990s.

For those who lose their jobs, the prospects for being rehired elsewhere are strong. Although a net average 105,000 jobs a month have been lost since March 2001, Labor Department data suggest that more than four million people change jobs every month through the normal process of hiring, firing and quitting. “Even in tough times, the U.S. labor market is enormously fluid,” says Robert Mellman, an economist.

The two-worker family provides an important cushion. In 2000, both husbands and wives worked in 56% of married couples, up from 50% in 1986. If one spouse gets laid off, the other may still be working. Charles Chandler lost his job as a computer-programming consultant at Sprint a few weeks before Sept. 11, but his wife, Pam, kept working as a teacher.