For the United States to prosper over the long run, we need to reduce the share of total output that households consume. We need to increase the proportion of income that households and governments save.
We need to increase investment in new plants, equipment and technology. We need to become less dependent on imports of goods and of capital.
East Asia is a mirror image of our nation. China, along with Taiwan, Korea and other nations, needs to increase the fraction of total output that goes to meet the needs and wants of households. They need to produce less for export and more for domestic consumption. They need to save less and invest less, particularly in bonds issued in the United States and Europe.
Both the United States and East Asia are on self-harmful trajectories that they simply cannot maintain over the long run. The problem is that neither seems to know how to make necessary changes. In both cases existing policies stem from powerful domestic political considerations.
Moreover, both regions now face the most threatening short-term economic dangers in decades. A deep, widespread recession, a new world depression, is a real possibility. With cruel irony, the adjustments that we inevitably must make in the long run would increase the short-run dangers of financial sector failures, falling output and rising unemployment. Both regions are in a quandary.
Right now, the United States is suffering the hangover of a consumption binge that lasted more than a decade. Credit was cheap. Mortgages were easy to get. Financial assets like 401(k) plans grew in value, year after year. Ditto for housing values. The federal government increased spending in many categories but lowered taxes. Consumer prices rose little compared to preceding decades.
China accomplished spectacular growth for decades, largely fueled by exports to wealthier countries. But part of its export performance grew out of the Chinese government buying up dollars and euros to keep those currencies valuable compared to the Chinese currency. It used the dollars bought in this export promotion effort to buy Treasury bonds and other dollar-denominated securities.
Manufacturing and commerce in China have their own bubble-like aspects. China has a very high savings and investment rate. Tens of billions of dollars have poured into new factories and office buildings. As for U.S. housing and retail, the rate of Chinese building probably has been higher than economically justified or sustainable over the long run. The country was due for some shakeout under any circumstances. Now the global economic crisis is forcing matters.
Despite some rhetoric from the left, current problems do not portend the end of market-based economic systems. But our economy would be much healthier if we would return to the savings and investment levels that prevailed until the last 25 years.
Recently, U.S. household consumption of goods and services neared 70 percent of total output compared to the low 60-percent range that prevailed from World War II until the 1980s. National savings, the amount by which household, business and government income exceeds spending, historically was in the 9 percent to 14 percent range. Recently it has been near zero.
The total of household consumption, business spending on new plants and equipment and government spending is greater than the value of all the goods and services we produce. The shortfall has to come from imports. And those imports have to be financed by borrowing from abroad. Our persistent trade deficits are the result of households and government spending more than their incomes.
Households need to spend less and save more. They cannot continue to rely on net worth that stems from increasing values of financial assets and housing, they have to actually set aside part of their income.
Government needs to save. Given the unwillingness of Congress, under the control of either party, to cut spending, that means increased taxes.
Moderated consumption by households coupled with an end to persistent government deficits is essential to a healthier U.S. economy in the long run. But it would hurt the economy right now as it balances on the brink of a historic recession. Money creation by the Federal Reserve along with sundry federal stimulus programs are intended precisely to boost household and business spending.
In the long run, China needs to produce more things for its still-poor populace to meet their needs and wants. It has to let its currency increase in value, and let exporting abate. But to do so right now would increase urban unemployment and social tensions that the communist regime already finds threatening.
There is no easy way for our society to transition from debt-financed high consumption to moderate sustainable growth. There is no easy way for China to shift from a reliance on domestic austerity and currency-manipulated exports to greater production to meet its still-enormous domestic needs.
Countries only make difficult changes when they have courageous political leaders. Barack Obama may have potential, but without bipartisan leadership in Congress, he can accomplish little. China’s bureaucratic government is even less promising. Don’t get your hopes too high.
© 2009 Edward Lotterman
Chanarambie Consulting, Inc.