Sunday, 17 May 2009

Trade and the worsening in the structure of US GDP under the impact of the financial crisis

A prime reason for the severe contraction in world trade accompanying the international financial crisis is shown in Figures 1 and 2 below.

Figure 1 shows the rapid shrinking of the US balance of trade deficit since July 2008. In that period the monthly US trade deficit has declined from $62.5 billion to $27.6 billion – a fall of 56%. On an annualised basis this is equivalent to a fall from a deficit of $750 billion a year to $330 billion. Such a movement, equivalent to a shift of $420 billion a year, necessarily sends deep shock waves through the international trade system.

Figure 1

09 05 16 Trade Balance


Figure 2 shows the means by which this reduction in the deficit has been achieved.

US exports and imports have both fallen, but the contraction in US imports has been far greater than the fall in exports. Since July 2008 US exports have fallen by 26.2% but imports have declined by 34.3%. Considering only visible trade, US visible exports have declined by 32.1% but visible imports have fallen by 38.4%. As was pointed out on this blog, and as is now widely reported, such falls in trade are more rapid than in 1929-30. 

Figure 2

09 05 16 E I % Change since maximum


The consequences of such trade shifts for the US balance of payments, and therefore the internal structure of the US economy, are equally clear.

Overall figures for the US balance of payments are not yet released but the US trade position dominates its current account balance.[1] The US trade deficit was reduced from 5.0% of GDP to 2.4% between July 2008 and March 2009. There is no shift in other components of the US balance of payments that could compensate for this, and when the overall US balance of payments is published it may be safely assumed that its deficit will be shown to have also shrunk in approximately the same proportion as the trade deficit.

Such a decline necessarily reflects the shifts taking place in the internal structure of US GDP. By an accounting identity a balance of payments deficit is exactly equal to the shortfall of domestic savings compared to domestic investment. As it has been noted on a previous post on this blog that the total US savings rate is not rising in any significant fashion this means that the entire improvement in the US balance of payments situation is due to a decline in US investment.

This trend is confirmed by examining the changes in the individual components of US GDP since the first quarter of 2006 – this date being the one after which US investment started to decline as a proportion of GDP. These are illustrated in Figure 3.

Between the first quarter of 2006 and the first quarter of 2009 US household consumption rose by 1.1% of GDP and government consumption rose by 1.2% of GDP. In absolute terms US household consumption rose from 69.6% of GDP to 70.7% of GDP and government consumption rose from 15.8% of GDP to 17.0%. That is the share of overall consumption in US GDP has risen by 2.3% since the first quarter of 2006.

In the same period formation of inventories fell from plus 0.4% of US GDP to minus 1.0% of GDP. The really major decline was in gross fixed capital formation. which fell from 20.0% of US GDP to 15.7% - a decline of 4.3% of GDP. In terms of comparisons to annual rates, US fixed investment in the first quarter of 2009 was at its lowest share of the the economy since the aftermath of World War II in 1946. 

Figure 3

09 05 15 Change in % of GDP since 1Q 2006


If a shorter time period is taken, since the beginning of the fall of overall US GDP in the third quarter of 2008, the same pattern appears. US household consumption has risen by 0.2% of GDP, government consumption has remained static, inventories have fallen by 0.6% of GDP, and fixed investment has fallen by 2.1% of GDP.That is

These figures make clear that the reduction in the US trade deficit has not been achieved through a
reduction in the share of consumption in GDP (i.e. a rise in savings)
but via a fall in US investment.Therefore rather than the financial crisis, and the various government financial packages, moving the US economy away from consumption and towards investment, the result which s required, they have so far increased the proportion of consumption in US GDP – the opposite of what is required. 

Such a trend has major short term and long term economic consequences.

First, unless the US can increase its rate of borrowing from abroad, that is balance of payments deficit widens again, any increase in the rate of US investment can only come at the expense of a reduction in US consumption. The key decisions as to whether such a reduction will occur through a fall in US consumer expenditure (with the ensuing political discontent) or through a reduction in government expenditure (defence, health, education) remains to be taken. So far all that has occurred, with the various financial packages, is that the existing pattern of unaffordable consumption in the US economy has been maintained - which has been financed by slashing investment. This is a formula for further strategic US economic decline.

Second, without an increase in investment it is hard to achieve US economic growth. Indeed at present all potential sources of demand in the US appear severely constrained. While household consumption is maintaining its share of US GDP it is nevertheless falling in absolute terms as unemployment increases and real wages decline for those in work. Government consumption cannot increase significantly, as the Presidential administration has made clear, due to the already existing scale of the budget deficit and the strain put on borrowing in the Treasury Bond market to finance this. Exports cannot increase due to the decline in world trade. US investment is not only not increasing but is falling as it takes the strain of the rebalancing between savings and investment caused by the decline in the US balance of payments deficit. With all potential sources of increased demand blocked the US faces an anaemic recovery even if the decline in GDP is halted.

Third, the underlying cause of both the problems in the US economy and the international financial crisis, is that the extremely low level of investment and savings by the US makes it unable to compete with other more dynamic economies – as seen in the US balance of payments deficit. A decline in the share of investment in GDP will make the US even less able to compete – meaning that the US will be able to contain its balance of payment deficit only by maintaining the economy in a state of low growth or recession.

In short, so far the various US financial stabilisation packages have prevented a collapse in the interbank lending market and halted the rapid decline in share prices – although they have not yet halted the decline in housing prices. They, however, have not solved the problem of excessive and unaffordable US consumption. On the contrary the structure of US GDP has so far deteriorated further.

The conclusion is that financial melt-down has so far been avoided but the underlying illness has not been cured. Therefore the symptoms of the underlying problems are likely to work through to the surface again. The only issue not yet known is in what form the symptoms will reappear.

Note

[1] The overall difference between the US balance of payments and its balance of trade deficits in the twelve month period to the last quarter of 2008 was 0.03% of GDP. The largest difference in any single quarter in the last ten years was 0.8% of GDP. These numbers are far too small to affect the trend of the huge shift in the US trade and balance of payments since July 2008.

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