Last week’s estimate of an anemic U.S. GDP first-quarter growth rate of 0.1% will be revised. Moreover, the good news regarding job growth in April suggests that the U.S. economy is expanding at a quicker pace in the second quarter. But a closer look at the first quarter data reveals a disturbing drop in investment and net exports that does not bode well for a reorientation of the U.S. economy.
The rise in economic activity was entirely due to a rise in consumption expenditures, which rose at annual rate of 2.04%. Gross private domestic investment expenditures, on the other hand, fell. Private nonresidential investment expenditures totaled $2.091 trillion, slightly down from $2.096 in the last quarter of 2013. Moreover, spending on new plants and equipment, when adjusted by GDP, reflects a continuation of a slow cyclical rise after the global financial crisis, with no sign of any acceleration:
|
Year |
Private Nonresidential Investment/GDP |
Federal Budget/GDP |
Current Account/GDP |
|
2004 |
11.92% | -3.36% | -5.06% |
|
2005 |
12.31% | -2.43% | -5.63% |
|
2006 |
12.82% | -1.79% | -5.74% |
|
2007 |
13.26% | -1.11% | -4.90% |
|
2008 |
13.19% | -3.12% | -4.61% |
|
2009 |
11.33% | -9.80% | -2.64% |
|
2010 |
11.09% | -8.65% | -3.04% |
|
2011 |
11.65% | -8.37% | -2.94% |
|
2012 |
12.13% | -6.69% | -2.70% |
|
2013 |
12.19% | -4.04% | -2.33% |
An investment “dearth” (or “drought’) is not unique to the U.S. Antonio Fatas has shown that investment expenditures as a share of GDP have fallen in the advanced economies. Restricted spending on new plants and equipment has been blamed for continuing low growth rates in these countries, presaging a new period of “secular stagnation.”
Stephen Roach, former chief economist at Morgan Stanley and currently a Senior Fellow at Yale University’s Jackson Institute, has another concern. In his recent book, Unbalanced: The Codependency of America and China, he writes about the breakdown of the pre-crisis growth models in the two countries. China’s rapid expansion was based on investment and exports, backed by high savings rates. In the U.S., on the other hand, consumption expenditures, financed in part by borrowing against rising home values, were the basis of the economy’s growth. The flows of goods and capital between the two countries established a pattern of co-dependency between them. But the crisis revealed the weaknesses of both patterns of spending, and the two countries need to rebalance and reorient their economies.
Roach believes that China is taking the first steps to change the structure of its economy. President Xi Jinping and Prime Minister Li Keqiang have pledged to increase the role of private markets in allocating resources. Economic growth will be based on domestic demand, which will be focused on consumer expenditures. Success is not guaranteed, however, as there will be resistance from those who profited from the old export-dependent model and government control of the financial system. The government also faces daunting environmental challenges.
Roach is decidedly not optimistic about the ability of the U.S. to make the corresponding adjustments to its economy. While the deficit in federal budget has shrunk (see above), household savings remain too low. The U.S., he writes “…has ignored its infrastructure, investing in human capital and the manufacturing capacity.” The recent fall of the U.S. current account deficit could be reversed if consumption expenditures remain the engine of economic growth.
Roach is not alone in his concerns about the need for increasing national savings. Former Federal Reserve Chair Ben Bernanke raised the same issue in testimony to Congress last year. Raising savings rates during an economic recovery, however, is difficult, particularly given the slow decline of unemployment. Moreover, the work of Thomas Piketty and others on income distribution has drawn attention to a troubling aspect of this issue: savings are concentrated among the those in highest income brackets who hold such a large share of the wealth in the U.S. Many Americans live paycheck to paycheck, with little opportunity of funding individual retirement accounts to finance their retirements.
Raghuram Rajan, in Fault Lines: How Hidden Fractures Still Threaten the World Economy, pointed to the connection between the U.S. external position and growing inequality. While the U.S. economy has largely recovered from the financial crisis, the “fault lines” that Rajan wrote about still exist. It will be a daunting challenge for the U.S. to increase national savings without reinforcing the “forces of divergence” that skew income distribution.
Just recently, China’s Ministry of Land and Resources found that 60% of China’s groundwater is polluted. (http://www.businessweek.com/articles/2014-04-25/government-study-finds-60-percent-of-china-s-groundwater-polluted). But that is just the tip of the iceberg for the country’s eco-crisis.
If China seeks to address its incredibly depressing environmental issues, perhaps instead of switching from demand from abroad to domestic demand, they should switch their growth strategy to emphasize services rather than goods. This suggestion is based on the following economic theory: as countries shift from manufacturing of goods towards service industries, the pollution output decreases in that country. But before then, pollution builds up while the country is still stuck in manufacturing. The more service oriented a country is, the more advanced the economy and the higher the GDP and wealth. Once the country passes a certain threshold of wealth and industry transition, the country’s citizens start to prioritize public goods such as clean air and water. But this is only in the instance that their other needs are met (as the country becomes more wealthier and advanced). The push for environmental cleanliness from citizens propels the government to take action. The bottom line in this theory is that unless the industry focus of a country’s economic growth is not reformed or revisited, then it is very difficult to address economic growth and environmental protection at the same time.
Therefore, while the role of consumption expenditures as the ‘engine of economic growth’ is dangerous in the U.S., it is also dangerous in China — it will propel growth in the manufacturing sector, leading to more pollution. Services sector is the way to go!
It would be ideal if the US could make substantial changes to their economic structure; however, because of the danger to increasing the income gap – quoted above – I doubt that it will be an easy feat to increase private savings considering the circumstances. It would disrupt an already sensitive political climate in the US. However, there seem to be several signs that the US economy will continue to slowly improve with the looming danger of a low savings rate ( Consumer Spending reports ) purely through the increase in consumer spending. Even though the recent jobs report stated that the wages remained stagnant, consumers continue to spend; therefore, it will be interesting to see what measures – if any – the government takes to increase savings rate as the economy slowly pulls out of the recession.
It will be interesting to see which of the two looming economic issues will take precedent in the US: the current account deficit or inequality. Typically, inequality has been brushed aside in wake of other goals (inflation, employment, BOP ) Yet, lately especially with Saez and Piketty’s work, and the increasing inequality more attention has been brought to this issue. Also I am curious about what economic tools can be used to fight rising inequality.
Besides the lack of clean ground water in China, how will the “environmental challenges” in China affect China’s recent stance on allowing private markets to determine the allocation of markets especially with the release of the UN report which blames human interference for climate change? Will China use its environmental challenges as an excuse not to privatize some markets?
Economic and Financial inequality is indeed a major issue in the US, and it is heartening to see that greater focus has been trained on this part of the US economy. Roach states that it is important to raise the infamously low savings rate in the US – because the Fed’s current method of “quantitative easing” with consumers spending wealth in the stock market is unrealistic. Due to the fact that very few Americans, and usually only the wealthy, benefit from this model. Thus increasing domestic savings will be crucial for supporting future growth.
Also interesting that alongside China’s pledge to increase private investment, and make domestic demand the main engine to drive growth – China is also increasing military spending by 12.2% – the largest since 2011. Giving another channel for both economic, and political, growth.
There is a definite need to change the economic structure in the United States. The U.S. can no longer rely solely on consumption expenditure to fuel economic growth, a fact that has become increasingly clear since 2008. However, it would be interesting to see the possibilities for policies that could raise national savings rates, especially among those who are lower on the income scale. Basic economic theory does not hold up to reality in this case, a decrease in taxes or increase in income will not always be split between savings and spending. It is important that the reality of American citizens living paycheck to paycheck is acknowledged and it would be interesting to see if this reality, along with personal debt, can be depicted in an economic model.
It is interesting to consider the political implications of restructuring the U.S. and Chinese economies. Shifting the economic growth models of China and the United States may shrink both China’s trade surplus and its holdings of U.S. debt. In today’s world, strong economic interdependence between the two countries creates incentives to maintain a relationship of engagement and cooperation. Weakening economic and financial ties, however, may lower the costs of conflict.
There exist a number of potential flashpoints that could lead to conflict between the world’s two greatest economic powers. As of now, any form of war seems unlikely. But absent economic interdependence, both the United States and China may become more assertive in the Asia Pacific region, and territorial tensions may eventually lead to large-scale conflict. Therefore it seems that as both countries begin to restructure their economic growth models and reduce interdependence, they should seek other, more innovative forms of engagement in order to maintain the relative regional stability that currently exists.
It will be really interesting to see how the U.S. will adjust its economy to increase national savings without creating further income disparity. Perhaps part of the answer would be for future policies to do more to encourage private savings, moving it towards opportunities for tax-deffered savings such as IRAs and 401K plans. David Laibson once suggested that one way to do that would be to increase participation rates in such plans. For example workers should be automatically enrolled in 401k plans, and given the option of opting out, rather than having a voluntary opt-in as is usually the case today.
The other piece of national saving is obviously public saving, which is much harder to increase, particulary in a time of economic downturn such as the one the U.S. is witnessing right now. I am curious to see how the U.S. government is going to go about raising it, especially given the controversy it creates between the Democrats and the Republicans.
One thing that I believe is important for the U.S. to consider before implementing any new policies, is how they will affect inequality which has been on the rise.
This is a really interesting blog post from Greg Mankiw from 2006, which talks about how to increase national savings, and it will be interesting to see if the pre-crisis recommendations would still apply now.
http://gregmankiw.blogspot.com/2006/04/how-to-increase-national-saving.html