Saturday, 31 July 2010

US 2nd quarter GDP figures - investment remains the key issue for US recovery

By John Ross

The publication of the US 2nd quarter GDP figures highlighted several striking and interlinked structural trends in the US economy. These go considerably beyond the well publicised slowing of the US economic recovery. They again make clear that the trajectory of the US economy will be determined by what happens to US fixed investment

The data confirms the US recovery is weak

Unsurprisingly, because it was anticipated, and as has been widely reported, the data confirmed the slowdown in US economic recovery. Taking the latest revised figures, annualised US GDP growth decelerated from 5.0% in the 4th quarter of 2009, to 3.7% in the 1st quarter of 2010 to 2.4% in the 2nd quarter.

US GDP remains 1.1% below its peak level in the 4th quarter of 2007. At the 2nd quarter’s rate of growth previous peak US GDP will not be regained until the 4th quarter of 2010.

Such figures have essentially decided the debate between those who argued that because the US downturn was very severe its economy would spring back strongly from recession, and those, such as the present author, who pointed to the underlying structural situation of the US economy and therefore argued recovery would be weak compared to previous US post-war business cycles.

Figure 1 illustrates how much weaker the present US economic recovery is than in previous post-war cycles. In the previous most serious post-war cyclical downturn, that following 1973, the US economy regained its previous peak level of production after eight quarters. In this recession after 10 quarters the US economy has still not recovered its peak GDP level.

As also widely reported, the new GDP data now calculates the US recession was deeper, and started earlier, than previously estimated. Peak US GDP is now analysed as having occurred in the 4th quarter of 2007 rather than the 2nd quarter of 2008 as previously estimated. The trough of US GDP in the 2nd quarter of 2009 is now calculated to have been 4.1% below the cyclical peak level - the previous deepest fall in a US post-World War recession, that after 1973, was 3.2%.

Figure 1

10 07 30 US Business Cycles

The fall in US investment

The driving force of the depth of the US recession is also clear. It was due to the decline in US fixed investment. As shown in Figure 2, measured in constant 2005 prices, US GDP in the 2nd quarter of 2010 was $147 billion below its 4th quarter 2007 level. However several components of US GDP are already above their 4th quarter 2007 levels - inventories are up $63 billion, government consumption up $112 billion, and net trade up $135 billion. Consumer expenditure was below its 4th quarter 2007 level but only by $80 billion. But US private fixed investment was down $412 billion - dwarfing all other contributions to the recession.

Figure 2

10 07 30 Compmonents of US GDP

Decline in investment centred in non-residential sector

This decline in US private fixed investment was not primarily due to the fall in residential investment created by the sub-prime mortgage crisis - as may be seen from Figure 3. The decline in US residential fixed investment, again in 2005 dollars, was $172 billion whereas the decline in non-residential fixed investment was $241 billion.

Figure 3

10 07 30 Res and Non-Res

Fixed investment and inventories

A further feature indicating the specific pattern of US recovery is the financing of gross domestic investment - i.e. fixed investment plus inventory accumulation. Although, as noted above, US fixed investment remained severely depressed, nevertheless for the first time for four years there was a small upturn, of 0.5%, in the percentage of US GDP devoted to fixed investment in the 2nd quarter - fixed investment rose to 15.6% of GDP from its low of 15.1% in the 1st quarter of 2010. This reflected a stabilisation of the share of residential investment in GDP and a slight increase in the share of non-residential investment - see Figure 4.

Figure 4

10 07 30 Components of Fixed Investment

However it is clear that the majority of the saving necessary to finance the small upturn in overall gross investment has come from a worsening of the US trade balance - i.e. from foreign borrowing. Since the low point of the recession, in the 2nd quarter of 2009, US fixed investment and inventory accumulation has increased its share of GDP by 1.6% - rising from 14.5% of GDP to 16.1%. However this increase was entirely due to inventory accumulation - the percentage of US GDP devoted to private sector inventory accumulation rose by 1.9%, from -0.6% of GDP to +1.3%. However US fixed investment declined by 0.2% of GDP in the same period - from 15.8% of GDP to 15.6% of GDP.

Precisely quantifying the contribution of borrowing abroad to the financing of inventory accumulation is not possible until the US balance of payments figures for the 2nd quarter are published in September. However US balance of payments figures are dominated by the US balance of trade. The US trade deficit has been steadily widening since the depth of the recession in the 2nd quarter of 2009 - see Figure 5.

The deterioration in US net exports in 2nd quarter 2009 to 2nd quarter 2010 was 1.1% of GDP - the trade deficit rising from 2.4% of GDP to 3.5%. This is equivalent to 69% of the increase in the percentage of GDP for investment - indicating that the majority of financing for the increased saving to finance inventory accumulation has come from abroad. Given that in this period there was no increase in fixed investment at all what is occurring is that the US economy has been borrowing abroad not to finance fixed investment but in order to fund inventory accumulation.

Borrowing from abroad to finance an inventory build up, rather than for investment in fixed assets which can increase productivity or capacity, cannot be considered a healthy pattern of growth.

Figure 5

10 07 30 Net Exports

How is the US economic downturn to be overcome?

The data above makes clear that the quantitative key to overcoming the US economic downturn remains the situation in US fixed investment. Some reports on the 2nd quarter GDP figures spoke of a 'surge' in US business investment in the quarter but this fails to place the increase in a long term context. Comparing 2nd quarter 2010 to 1st quarter 2010, total US private investment rose by an annualised 19.1% or by $84 billion in 2005 prices. This sounds dramatic until it is noted that between 4th quarter 2007 and 2nd quarter 2009 US fixed investment fell by $495 billion so that the 2nd quarter 2010's increase made up only 17% of the fall that took place to the trough of recession. Only if an investment recovery continues for many quarters will the severe fall in US fixed investment during the recession be made up.

Such a fixed investment wave, in turn, would have to be financed by an equivalent rise in savings and therefore either by a sharp increase in US domestic savings or a large inflow of foreign capital. The former would require compression of US consumption, which would be likely to create major political unpopularity for the Obama administration, while the latter would require a major widening of the US balance of payments deficit. So far, as noted above, the primary process which has taken place is a worsening of the US trade deficit.

Why does the US not launch a major state investment drive?

Some authors argue that the way out of this current situation is for the US to launch a major state financed investment programme - a coherent exposition of this argument is presented for example in Richard Duncan's The Corruption of Capitalism. The arguments of adherents of this view is that due to the debt laden situation of the US private sector, and therefore its inability to sustain large scale expenditure, the US government, to maintain economic demand, has in any case no option but to continue to run large scale budget deficits for the foreseeable future. Therefore, instead of being used to maintain consumption, as at present, the budget deficit should instead be used to increase investment. As Duncan argues:

'Trillion dollar annual deficits for the next decade may keep the United States from collapsing into a severe depression.... But they would do nothing to restore the economy's long-term viability... The trade deficit would still be massive... The country could continue to consume more than it produced as long as other countries continued to accept its IOUs. But with each year that passed, structurally the economy would become increasingly rotten...

'There is a much more attractive alternative future, in which the United States remains the world's dominant superpower with a revitalised, self-staining economy. That alternative requires a national industrial-restructuring programme in which the government would invest in 21st Century technologies with the goal of establishing an unassailable American lead in the industries of the future. That goal could be achieved at the cost of $3 trillion over 10 years.'(1)

Such a programme for reversing the US investment decline is intellectually coherent but unfortunately in practice it is impossible to deliver given the structure of the US economy. The reasons why this is the case also show why the the Obama administration has been unable to step in and launch any large scale state financed investment programme.

The first obstruction is political - any US administration pursuing such an approach would get little or no popular support for doing so. Popular political sentiment is not determined by GDP growth statistics, let alone investment statistics - about both of which most of the population knows little and cares less. Political popularity is determined by whether living standards are rising or falling. Whereas government programmes boosting consumption improve living standards, and therefore are popular, programmes boosting investment have no such direct effect and are therefore unlikely to be generate equivalent political popularity.

More fundamentally, at the economic level, large scale government intervention in investment would alter the balance between the state and private sectors in the US and increase the weight of the former. This would therefore require a sharp shift in the structure of the US economy and would also be strongly resisted on ideological grounds.

It is for this reason that while the Obama administration has been able to use the budget deficit with considerable effect to maintain both private and government consumption it has been unable to have any significant effect on US investment. As may be seen in Figure 6, expressed in current prices, the $41 billion increase in US state investment between the 4th quarter of 2007 and the 2nd quarter of 2010 offset only 8.5% of the $485 billion decline in private investment which took place in the same period.

Figure 6

10 08 01 Private and State Investment

Furthermore whatever increase in state investment did take place was almost entirely in the ideological acceptable, but economically unproductive, field of military spending. As may be seen in Figure 7, between the 4th quarter of 2007 and the 2nd quarter of 2010 while US Federal military fixed investment went up by $28.8 billion in current prices, Federal civilian investment went up by only $9.0 billion and fixed investment by the fifty US States went up by only $3.0 billion. Therefore not only was the total increase in US state investment far too small to offset the fall in private fixed investment but the increase in civilian state investment was negligible. Figure 8 shows the same trends in fixed price terms.

The idea of state action to overcome the investment decline in the US is therefore interesting in theoretical terms. But it is impossible to execute in the actual structure of the US economy.

Figure 7

Fixed Investment by Govt Sector

Figure 8

10 08 01 Private and State Investment

China's response compared to the US

Several conclusions follow from the above data.

  • It is evident why the US recovery from recession has been weak and is likely to continue to be so - a huge decline in fixed investment has to be made up.
  • It is likely the US trade deficit will continue to expand. Financing a recovery in investment from US domestic savings would be likely to require compression or slow growth of US consumption which would be highly unpopular. It is therefore easier for the US economy to finance an investment recovery through expansion of foreign borrowing - i.e. to widen the balance of trade deficit.
  • It is evident why China has come so much more successfully through the international financial crisis than the US. As has been analysed elsewhere the general overall characteristic of the present 'Great Recession', internationally and not simply in the US, is a severe decline in fixed investment. China's own stimulus programme however, by directly boosting investment, ensured that no such decline took place in China. On the contrary, the period following the start of the international financial crisis saw a sharp increase in fixed investment within China.The programme prescribed by Richard Duncan and others for the US - 'a national industrial-restructuring programme in which the government would invest in 21st Century technologies' - is impossible for the US to execute for reasons already analysed. However it appears to be rather close to what China is actually executing.
  • Far more successful economic performance by China than by the US therefore seems certain to continue in the next period with its concomitant consequences for the world economy.

    Notes

    1. Richard Duncan, The Corruption of Capitalism, CLSA Books, Hong Kong 2009.

No comments: