 Why the crisis is far from over: |
Conference |
| Saturday 11 July 2009 |
Speakers include: Ken Livingstone Geoffrey Robinson MP |
Discussions include: • 1929 revisited? |
 Registration£10 waged; £6 unwaged; £20 organisations For enquiries email: info@progressivelondon.org.uk |
| Progressive London is a cross-party, cross-community forum initiated by Ken Livingstone. |
Wednesday, 1 July 2009
Conference - The Global Economic Crisis
Sunday, 28 June 2009
Latest data confirms fall in investment dominates the US recession
The final published revised figures for US 1st quarter 2009 GDP confirm just how dominated the current US economic downturn is by the precipitate fall in investment.
Figure 1 shows the percentage change in domestic components of US GDP since the onset of the recession, following the second quarter of 2008, up to the first quarter of 2009.
US GDP in this period declined by 3.1%. Personal consumption, however, fell by only 1.7% while government expenditure rose by 0.9%. In contrast private fixed investment dropped by 20.7%.
Figure 1
The trend may be equally clearly seen in Figure 2 which shows the change over the same period in the constituents of US GDP in constant price dollar terms - all figures using dollar prices of 2000.
Figure 2
Two components of US GDP have actually grown, or improved, since the downturn commenced following the second quarter of 2008. Due to US imports falling more rapidly than exports US net trade has improved by $84.5 billion. Simultaneously government expenditure has risen by $19.5 billion.
The decline in US GDP is accounted for by a decline in inventories, personal consumer expenditure and private investment. Taking these in terms of their quantitative impact, inventories have declined by $53.1 billion, personal consumption expenditure by $143.3 billion and private fixed investment by $352.8 billion. The decline in US private fixed investment is therefore almost seven times the size of the decline in inventories and almost two and half times the scale of the fall in private consumption.
Analyses of the US economic downturn which focus on the decline in inventories or personal consumption therefore miss the main constituent of the recession.
Nor, contrary to statements by Paul Krugman and others, is the fall in US investment only accounted for by the decline in residential investment. From the second quarter of 2008 to the first quarter of 2009 the decline in US residential investment was $75.4 billion and the decline in US non-residential investment was $241.2 billion - i.e. the fall in non-residential investment accounted for more than three times as much of the declines in US GDP as the fall in residential investment.
These final US GDP figures therefore leave no ambiguity. The US economic downturn is being driven by a huge fall in investment.
This fall in investment will have clear short term and long term consequences. In the short term, in terms of the business cycle, as the investment decline is driving the recession, unless this is reversed it will be very hard for the US to escape from economic recession or stagnation.
Regarding the longer run modern econometric research clearly confirms that it is investment which has been the main driver of US economic growth - i.e. the old claim, associated with Solow and Kuznets, that it was productivity and technology, and not capital and labour growth, which drove economic growth has been shown to be factually false.
As Dale Jorgenson, former President of the American Economic Association and the foremost econometrician studying US economic growth, put it in a survey of the latest evidence in 2009: ''the growth of productivity was far less important than the contribution of capital and labour inputs to US economic growth.' More specifically he notes the evidence leaves no doubt 'investment is the predominant source of U.S. economic growth' [1]. The very sharp current decline in investment, in addition to its short term cyclical effects, therefore also undermines the main source of US economic growth - making it hard for the US to resume rapid economic development.
The investment driven character of the US downturn therefore has major short term and long term consequences for both the US and world economies.
* * *
This article originally appeared on the blog Key Trends in Globalisation.
Notes
[1] Dale W. Jorgenson, Productivity Volume 1: Postwar U.S. Economic Growth, The MIT Press, Cambridge Massachusets 1995 pxv.
Monday, 1 June 2009
Sense on China's savings from Hong Kong
One of the stranger attempts to apportion blame for the international financial crisis has been the claim that China is allegedly saving too much. A brief consideration of economic fundamentals will show the economic incoherence of this view.
Consider first China’s domestic situation. China requires a high savings rate in order to finance its high level of investment. As the evidence shows that the most important determinant of the rate of economic growth is the rate of increase of investment and labour, if China were to cut its rate of investment its economy would grow less rapidly. Furthermore, China’s growth is responsible for the majority of the reduction of the number of people living in poverty in the world. Reduction of China’s rate of investment, which in turn requires a high savings rate, would therefore result in China’s economy growing less rapidly, the world economy growing less rapidly, and world poverty shrinking less rapidly - clearly nothing positive lies down that road either for China or for anyone else. On the contrary, as the Indian Prime Minister has stressed countries such as India and China require high savings rates.
Internationally what is normally argued by the ‘China is saving too much’ view is that the key issue is to reduce China’s balance of payments surplus – the latter being statistically necessarily equal to China’s surplus of domestic savings over domestic investment. A case can be certainly be made that China should utilise a higher proportion of its savings domestically. Investment in the domestic Chinese economy would almost certainly earn a better rate of return than the present situation of large scale purchases of US Treasury Bonds. It might also lead to more rapid economic growth by China. The latter however depends on other factors as well - for example, prior to the financial crisis last year China’s economy was in danger of overheating and encouraging a higher level of investment would have exacerbated this. But a high investment level is certainly a means by which China's balance of payment surplus could be reduced.
But what would be the consequence of China reducing its balance of payments surplus in the present circumstances – whatever the means chosen? China recirculates its surplus in large part through purchase of US Treasury Bonds – that is, China adds to international savings. Reduction in China’s balance of payments surplus, unless compensated for by an increase in savings elsewhere, would inevitably lead to a rise in interest rates as the international supply of savings shrank – a likely form being a very direct increase in the interest paid on US Treasury Bonds. Such a rise in interest rates, under conditions of a world economic downturn, would be highly undesirable as so far there is no indication at all of an increase in the overall US savings rate that would compensate for a decrease in international saving by China. Such an increase in international interest rates would be economically contractionary when the opposite is what is required.
More fundamentally what choice did the increase in international savings by China offer to the US - and other economies? In essence it simply meant the US economy was able to borrow money at extremely low interest rates. That finance could have been used to rebuild the productive base of the US economy - that is, it could have been invested. That such finance available at low interest rates was not invested but was instead wasted in a consumer splurge was the result of economic policies pursued by successive US government not others. Others could have used such low interest rate finance for productive purposes.
An article in China Daily on 29 May by Lau Nai-keung put the issue in rather popular and polemical style with a distinct Asian emphasis - but he actually stated the question very accurately as regards economic fundamentals (incidentally rightly linking it to the need to raise investment for environmental reasons). Lau Nai-kueng is from Hong Kong.
’The [Chinese] government has decided to make domestic consumption the engine of sustained growth. But many people tend to confuse it with personal consumption...
‘On completing these tasks, the government can consider a free or highly subsidized transport system. Beijing’s example of subsidized subway transport is a good example of minimizing the risk of abuse in public service. Once a smooth and efficient public transport, which is free or subsidized, is in place, owning a car would only be a status symbol. The government can then think of scrapping hire purchase for cars so that fewer vehicles are on the streets. That will not only ensure a freer flow for public transport vehicles, but also mean reduced greenhouse gas emission...'Before the [1997] Asian financial crisis, credit cards were not very common in South Korea. But after that, credit cards were dished out on the pretext of boosting consumption, and transformed almost the entire country into a group of ruthless spenders. The savings rate of South Koreans has dropped drastically, and as a result the country is now finding it difficult to weather the global economic storm.
‘In the US, most people are... spending money they have not earned. Ironically the economic crisis has forced people to rely even more on credit cards to maintain their lifestyle... Outstanding payment for credit cards worldwide is estimated to be more than $1 trillion and rising. Like subprime loans, card payments are also packaged in different kinds of derivatives, and when bad loans pile up, as is inevitable, another wave of financial tsunami will lash the global economy.‘We have to learn to make good use of our high savings rate, instead of encouraging the middle class to buy more houses and cars, and spend like there is no tomorrow. Most of the suggested measures does not require a lot of resources to implement and, in fact, will reduce pollution. On the contrary, they will help create quality employment and generate solid GDP growth.
‘When welfare schemes make people feel more secure, they would be more willing to spend. The social and economic infrastructure will also ensure sustained economic growth. Proper channelling of savings into investment and social spending will enhance real private consumption in the long run. Higher savings will then imply higher investment and, in turn, higher GDP and a more robust growth. Without proper savings, a high private consumption rate will lead to disaster, as has been the case in many Western countries.
‘If a high savings rate is as bad as many Western economics would like us to believe, then how come we have succeeded and they have failed to weather the economic storm?’The last sentence would seem to hit the nail rather accurately on the head.
Friday, 29 May 2009
Comments on Paul Krugman and Alwyn Young on The Myth of Asia's Miracle - why 'quantity' may be more important than 'quality' in economics
Preparing for a panel discussion with Paul Krugman at Jiao Tong University in Shanghai led to reflection on how different the parameters of practical policy making are from those of academic economics. The questions asked and point of approach are frequently divergent
In policy making all theoretical and other arguments have to be aligned and concentrated around one settling one decisive issue - ‘what should be done’. That is, what is involved is a synthetic decision – assembling issues, and giving them their specific weights, around one point. In academic discussion exploration of distinctions and points can be pursued without settling the decisive practical question of what difference it makes to what should be done.
This particular reflection was reinforced by re-reading, to prepare the debate, Paul Krugman’s well known 1995 paper, ‘The Myth of Asia’s Miracle’. This analysis, arguments from which are still frequently used today, drew heavily on two quantitative papers by Alwyn Young on growth in the four Asian Tigers/Newly Industrialised Economies (NICs) of South Korea, Singapore, Taiwan and Hong Kong.[1]
In analysing the Asian Tiger economies Young/Krugman were attempting to deal with a theoretical/analytical issue. Was the rapid rate of growth of the South East Asian Tigers based on, or substantially contributed to, by a particularly high rate of growth of productivity – whether of labour, capital, or total factor productivity? Or to what degree was it based on quantitative growth of factors of production – i.e. accumulation of labour and capital?
It should be noted that the quantitative results of Young’s work has come under criticism - notably from Chang-Tai Hsieh. However, for the moment, leave statistical criticism aside and assume, for the sake of argument, that Young’s quantitative conclusions were correct – although, to be clear, this is done as a hypothesis and is not an acceptance of Young’s calculations per se. Then what follows?
Writing in 1995 Young noted that for the period 1960-85 the four Asian Tigers constituted four out of the five countries with the fastest growth of GDP per capita in the world - the fifth, Botswana, was an economy sufficiently small that no general conclusions would be drawn from it. However, after subtracting growth due to the increase in labour input (including increased participation in the workforce, higher educational achievement etc) and the rate of additions and improvements to capital, Young concluded that the growth of total factor productivity in the Asian Tiger economies was not remarkable. Summarising his article, Young wrote that he:
‘presents estimates of “total factor productivity” in the sample economies... the ranks of Taiwan and South Korea [among economies placed in descending order of growth of total factor productivity] are now reduced to 21st and 24th, respectively. While this remains a strong performance, it is no longer dramatically differentiated from that of the rest of the world economy. Fully 81 of the 118 sample economies lie within one standard deviation… of Taiwan and South Korea. Surprisingly, economies such as Bangladesh, Uganda, Iceland and Norway are now seen to have outperformed Korea and Taiwan, whose productivity growth is only 0.5% greater than that of a renowned laggard, the United Kingdom. Singapore, where participation and investment rates have risen faster than any of the NICs, is reduced to a rank of 63rd in the world economy.’
So, therefore, Young finds the growth of productivity in the NICs was average or slightly above average and their rapid growth was not primarily due to extraordinary growth in total factor productivity but was due to large scale quantitative inputs of capital and labour. To which the appropriate answer, from the point of view of economic growth, is: ‘yes, that is quite adequate, even very encouraging. For it shows that if it is possible to combine average productivity growth with very large quantitative inputs, then the economy’s rate of growth will be far higher than the average and very rapid in absolute terms – enough to industrialise a country in a single generation (which is what the NICs achieved).’
The point is a simple arithmetic one. The effectiveness of the contribution of investment, for example, to economic growth depends on the combination of its quantity and how efficiently the economy utilises it. This blog has noted on numerous occasions that there is a fundamental logical error in judging an economy’s growth potential by economic approaches which concentrate only on the efficiency of the use of investment rather than also analysing the quantity of investment. The quantitative relation of the relative scale of investment and the relative efficiency of investment is the critical one. If, for example, economy A utilises investment 20% more efficiently from the point of view of generating growth than economy B, but nevertheless economy B invests 50% more as a proportion of GDP, then economy B will grow more rapidly than A despite the fact that economy A uses its investment more efficiently.[2]
Young/Krugman demonstrate that the rate of productivity growth of the Asian Tiger economies is not below average, but only average, as a result of which these economies quantitative advantage in growth of inputs of investment and labour ensures much more rapid growth that economies with higher rates of total factor productivity growth but much lower rates of input growth.
This is why, for example, criticisms that countries such as South Korea, during their phases of rapid growth, allegedly allocated capital inefficiently compared to more ‘liberal’ economies such as Britain or the United States entirely miss the point. An economy such as South Korea invested so much more as a proportion of GDP, almost double the rate of the US, that unless, from the point of view of growth, its' efficiency of investment was only half that of the US the South Korean economy would still have grown more rapidly than the US.
Put in properly formulated economic terms the quantitative level of macro-economic allocation of resources to investment may be more important from the point of view of economic growth than the marginal efficiency of investment. Put crudely, when it comes to investment and growth, 'quantity; may simply be more important than 'quality'. That, for example, would by itself be enough to vindicate the present very high rates of investment in India and China.
Whether it has proved in practice a more viable growth strategy to have an average rate of growth of productivity, combined with very high quantitative inputs of investment and labour, or whether it is more effective to aim at the highest rate of growth of total factor productivity, with much smaller quantitative inputs of investment and labour, may be illustrated rather graphically by showing the rank order of countries produced by Young’s calculation.
Young found that the top five countries in terms of growth of total factor productivity, after he has carried out his adjustments, were as set out in Table 1.
Table 1
In short, if highest possible growth in total factor productivity is the variable that should be targeted, then Egypt, Pakistan, Congo and Malta, together with Botswana, should be taken as the most successful economies in the world – the economic models to be emulated.
If, however, the key criteria of success is increase in GDP per capita, achieved, according to Young’s calculation, by the Asian Tiger economies combining average rate of growth in total factor productivity with massive quantitative inputs of investment and labour, then in contrast Table 2 shows the world ranking of economies.
Table 2
Which economic variable is in practice decisive in determining real economic outcomes may be shown graphically by taking the case of by far the worst performing case of total factor productivity according to Young/Krugman’s account – Singapore.
Singapore, poorly performing in terms of total factor productivity, has today, in Parity Purchasing Power terms, the 5th highest GDP per capita in the world – a level 9% higher than the United States. Egypt, which is better performing in terms of growth of total factor productivity, ranks 101st in the world with a GDP per capita only 13% that of the United States. While the second ranking, from the point of view of total factor productivity growth, Pakistan ranks 130th in the world with a GDP per capital 6% that of the US.
In short, taking for arguments sake Young and Krugman's calculations as entirely correct, then the route to actual economic success, in terms of economic growth and a high living standard, lay in the average rate of increase of total factor productivity, combined with massive quantitative inputs of capital and labour, of Singapore rather than in the high total factor productivity, combined with far lower quantitative growth of inputs, of Egypt, Congo and Pakistan. Or, put in deliberately shocking terms, 'quantity' (growth of factor inputs) was much more successful in determining growth in GDP per capita than 'quality' (growth in total factor productivity)!
It is, of course, possible to have a rate of growth of total factor productivity that is so low (potentially a negative number) that even the greatest increases in quantitative inputs cannot produce viable growth – the USSR in its final period represents such a case. But the case of the Asian Tiger economies showed that provided close to average increases in total factor productivity can be achieved then quantitative increases were the decisive ones. Put formally, the evidence is that provided an average, or near to
average, rate of total factor productivity growth can be achieved then
ensuring very large quantitative inputs proved a more viable growth
strategy than aiming to maximise efficiency – i.e. total factor
productivity growth.This is simply the arithmetical outcome of multiplying the rate of growth of factor productivity by the rate of growth of inputs. The criteria which must decide the strategy chosen is therefore that which maximises the rate of growth of GDP per capita, not the abstract theoretical one of maximising rate of growth of factor productivity.
Turning to India and China this has an immediate practical consequence. It means that even if it were to be assumed, for the sake of argument, that the efficiency of their use of investment were average, or even somewhat below average, then they might well be right to concentrate on massive inputs – to take the Singapore route. That, in turn, evidently raises the question of whether investment in India and China actually is inefficient – which goes beyond the scope of the present article, but will be returned to in a future article. But it should be noted from the above that even if, for the sake of argument, it were assumed that Krugman and Young’s quantitative premises are correct then this does not constitute a valid argument, from the point of view of the key variable of maximising the rate of growth of per capita GDP, against the effectiveness of the growth model followed by either the South East Asian Tiger economies or current policies pursued by India or China.
As stated at the beginning of this article, in economics quantity in some cases may simply be more important than quality.
* * *
This article by John Ross originally appeared on the blog Key Trends in Globalisation
Notes
[1] The argument of all three papers by young and Krugman was that the rapid growth of the NICs was based on quantitative accumulation of inputs of labour and capital and not on any productivity growth that was remarkable by international standards. The same analysis was then applied to China in Young’s 2003 paper ‘Gold into Base Metals: Productivity Growth in the People’ Republic of China during the Reform Period’.
[2] Ideally, of course, a combination of the maximum level of efficiency of investment from the point of view of economic growth and the maximum level of inputs would be achieved. However, while this is optimal in a purely abstract theoretical model in practice it may be necessary to chose between the two. An evident case of this is heavily state influenced financial systems aimed to maximise savings, as for example existed in Japan and South Korea during periods of rapid growth, versus those which are aimed to maximise the efficiency of use of savings. General discussion of this point, however, goes beyond the scope of this article.
Monday, 18 May 2009
Paul Krugman at Jiao Tong University Shanghai - by John Ross
Paul Krugman, 2008 Nobel Economics Prize Winner, chiefly for contributions to ‘New Trade Theory’, and well known New York Times columnist and blogger, under the rubric ‘Conscience of a Liberal,’ was in Shanghai last week delivering a speech on the present international financial crisis at Jiao Tong University. The event attracted wide media coverage in addition to over 1,000 people in the immediate audience. For those able to read Chinese a full account, including on specific issues to deal with the China, can be found here. As I was on the panel with Krugman discussing his talk afterwards it was an excellent opportunity to clarify issues with someone who is now one of the most influential economic voices in the US.
Krugman’s sincerity, good intentions, and factual knowledge were beyond dispute. He bluntly contrasted the new situation for rational discussion under the Obama administrations, in comparison to George W. Bush's, as the ‘difference between light and darkness’. Krugman’s overall economic perspective, with a major exception discussed below, was rather realistic - the format of a nearly one hour talk, followed by two hours of panel discussion and audience questions, giving considerably greater opportunity for detailed clarification than newspaper columns.
Krugman outlined his view that ‘probably’ the world economy would escape a 1930s type depression – noting that the fact he had to use the word ‘probably’ showed how serious the situation was. What he however considered possible, and feared, was a prolonged economic stagnation, or anaemic recovery, similar to the 1990s ‘lost decade’ in Japan. In such a perspective there would not be a 1929 type collapse in production but only a weak and protracted US recovery – i.e. a prolonged period of US economic stagnation. According to the latest survey by the Wall Street Journal such a perspective has now become the dominant view among US economists of diverse theoretical outlooks.
Krugman’s own argumentation for such a perspective was Keynesian – he restated Keynes was his ’god’. The present blog, in contrast, would not agree with such a line of reasoning - and would stress supply side factors rather than those rooted in demand stressed by Keynes. The reasons for this are that additions to effective demand are ineffectual rather than raising output, or merely produce inflation, if the appropriate conditions for increasing production do not exist on the supply side of the economy. This is not merely the case under the well known condition that spare capacity does not exist in the economy, in which case evidently increased demand cannot translate into increased output, but, in a private sector dominated economy, under conditions in which profitable increases in output cannot be undertaken. Nevertheless, analysing the supply side, then provided rational economic policies are adopted a 1929 style collapse, if not a significant period of relative economic stagnation in the US and Europe, should be avoidable.
The reason for this lies in the different state of the world economy today compared to 1929. In 1929 the US was not only the world’s largest economy but also its most dynamic. When the US financial system imploded in that year there was therefore no backstop to prevent the whole world economy being dragged downwards.
Today the world’s most rapidly growing economies are in Asia not in the US. India has the second most rapidly expanding economy in the world and is coming through the international financial crisis with a slow down in the rate of growth in GDP but no contraction of the type seen in the US and Europe. China’s savings, i.e. its finance available for investment, are as large as those of the US in absolute terms. Some other South East Asian states are continuing to grow – although a number, such as Singapore and Hong Kong, have suffered severely from the financial crisis. In short there is today an economic and financial backstop to the US, unlike in 1929.
These economically more dynamic Asian states are not large enough by themselves to propel strong overall world economic growth. China, India and the economies of the other South East Asian states taken together are still somewhat smaller than the US economy. But they are large enough, provided rational economic policies are pursued elsewhere, to prevent an international 1929 type collapse. Relative stagnation in the US and Europe, accompanied by growth in major parts of Asia, is therefore a realistic perspective for the world economy - even if the present author would arrive at that conclusion via a rather different perspective than Paul Krugman - Krugman did not outline his specific perspective for Asia. The proviso, however, is provided ‘rational’ policies are pursued and this is where the differences with Krugman developed in the debate.
Relative economic stagnation in the US and Europe, accompanied by still relatively strong economic growth in China and India, necessarily means a further shift in the economic relation of forces in favour of the latter two countries. From the point of view of the world economy and its recovery, or of increasing the standard of living of the two and a half billion people in these countries, of course, this is no problem. But it is for those who approach the financial crisis not via the angle of what is good for the world economy but from that of how to maintain the dominance of the US in the world. It is this which produces the danger of policies being pursued that are not economically rational.
The underlying problem in the world economy at present is that at its current rate of investment in GDP the US cannot compete, at anything like its present exchange rate, with the rising Asian economies. This is the cause of the well known US balance of payments deficit. US consumption has therefore been kept higher than its production via a massive borrowing from abroad that is ultimately unsustainable. The only way stabilisation can be achieved is therefore through a reduction in US consumption. This, in turn, can only take place through means that are either extremely painful for the US population in terms of reduced living standards (a reduction in the share of household consumption in GDP) or by means which probably involve reductions in US military spending (that is if a reduction in government consumption is not to take place in the fields of health and education). In short, to adapt the old phrase, the US can afford butter or guns but it can no longer afford both.
The attempts by the Obama administration to avoid this choice between butter and guns, that is to maintain both the high level of household consumption in US GDP, together with spending on health and education, while simultaneously refusing to cut the military budget has only been achieved through a radical reduction in US investment. But such a strategy is not viable in anything other than the short run as it undermines further the competivity of the US economy – the original cause of the crisis. The inescapable choice between butter and guns therefore still lies ahead for the US.
Paul Krugman, when questioned, however would not accept the importance of the low US investment rate. He also argued that in any case he could see no policy which could reverse this. He also stated the further decline in US investment was only due to the fall in residential investment under the impact of the sub-prime mortgage crisis.
First these statements are factually incorrect. While the decline in US investment certainly started in the residential sector, under the impact of the sub-prime mortgage crisis, the largest fall in US investment since the financial crisis started in September 2008 has been in non-residential investment. Between the third quarter of 2008 and the first quarter of 2009 US residential investment fell by 0.6% of GDP but non-residential investment fell by 1.6% of GDP i.e since the beginning of the international financial crisis 72% of the decline in the proportion of US GDP devoted to investment has been caused by a decline in non-residential investment and only 28% is due to a decline in residential investment.
These trends are shown in Figure 1, which graphs the decline in the components of US GDP as a percentage of total GDP since the third quarter of 2008, and in Figure 2 – which shows the decline in residential and non-residential US investment as a percentage of GDP over the same period. These trends make it clear that since the financial crisis broke out it is the decline in non-residential US investment, not in residential investment, that has been the driving force of the economic downturn.
Figure 1
Figure 2
Second, however, a decline in residential investment is by itself destabilising. It both reduces overall demand in the US economy and will be a contributory factor to macro-economic destabilisation created by future house price bubbles – such bubbles are due not only to excessive demand, due to excessively lax monetary policy, but to shortages in supply due to lack of investment in housing stock. This is clear from the experience of countries such as the UK, where house price bubbles have been worsened by shortage of supply, particularly in specific areas of the country such as London.
Third, contrary to Paul Krugman’s reply, it is evident that there are policies which could raise US investment. Shortage in US savings, accompanied by a balance of payments deficit, is simply another way of saying that the US is consuming more than it produces. Increased investment, financed from within the US, requires that the share of consumption in US GDP must be cut. As noted above that can either be done by reducing living standards, that is reducing household consumption, which presumably Paul Krugman would not want, or by reducing government consumption. Releasing resources in these ways would stimulate investment both via indirect means, ending the excessive calls on available resources leading to a reduction in interest rates, or via direct ones, the government for example increasing tax breaks for investment, or both. Therefore it is simply not true that there are no policies which would increase US investment.
What is true, however, is that such policies would require a change in the shape of the US economy. However that is precisely what is required - as it is the present unsustainable excess of US consumption over US production that led to the financial crisis. Maintenance of the present structure of the US economy merely means that the crisis will reappear even if the most immediate wounds are bandaged up through the financial stabilisation packages.
In short, the error of Paul Krugman’s perspective was that it underestimates the reshaping of the US economy that is required. This error is in line with the present policies of the Obama administration which, as discussed on previous posts on this blog, are also essentially maintaining the existing pre-crisis structure of the US economy. Whether or not the immediate US government packages stabilise financial markets, which remains to be decided, the fact that the underlying distortions of the US economy have not been resolved means that in the medium term, and possibly in the short term, various symptoms of the crisis will reappear.
The discussion with Paul Krugman in Shanghai was therefore enlightening not only from the point of view of its discussion of China but from the point of view of analysis of the US economy. It revealed Paul Krugman, together with the Obama administration, underestimates the scale of transformation which is required in the US economy.This misunderstanding by the Obama administration will doubtless have significant consequences in the months to come. Altogether a clarificatory event.
This article originally appeared on the blog Key Trends in Globalisation
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