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

% Components Q2 2008

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

$ Components Q2 2008

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.


[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...

‘Hong Kong’s experience of the 1990s, when it saw more than six years of deflation, tells us that an economy doesn’t need excessive subprime loans to create a big enough bubble in the property market that would hurt everybody once it bursts.

‘The experience taught us that a high rate of savings should be viewed as a virtue, not as a vice. It’s the inappropriate use of savings that is to blame for the economic ills of today. The Chinese mainland’s rapid growth is attributed to massive infrastructure building financed by a high savings rate. The yield from investment into infrastructure is long-term.

'Putting more resources into education, healthcare and the environment is also investment. And such an investment has for long been overdue on the mainland...After that, we can increase the spending on social security and housing for low-income groups, which are not investment but nevertheless are very important components of social security because they enhance general welfare, social stability and harmony.

‘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.