Sunday, November 23, 2014

America’s Other 30%

NEW HAVEN – The American consumer is but a shadow of its former almighty self. Personal consumption in the United States expanded at only a 1.5% annual rate in real (inflation-adjusted) terms in the second quarter of 2012 – and that was no aberration. Unfortunately, it continues a pattern of weakness that has been evident since early 2008.

Over the last 18 quarters, annualized growth in real consumer demand has averaged a mere 0.7%, compared to a 3.6% growth trend in the decade before the crisis erupted. Never before has the American consumer been this weak for this long.

The cause is no secret. Consumers made huge bets on two bubbles – housing and credit. Reckless monetary and regulatory policies turned the humble abode into an ATM, allowing families to extract dollars from bubbles and live beyond their means.

Both bubbles have long since burst, and US households are now dealing with post-bubble financial devastation – namely, underwater assets, record-high debt, and profound shortages of savings. At the same time, sharply elevated unemployment and subpar income growth have combined to tighten the noose on over-extended consumers.

As a result, American households have hunkered down as never before. Consumers are diverting what little income they earn away from spending toward paying down debt and rebuilding savings. That is both logical and rational – and thus not something that the US Federal Reserve can offset with unconventional monetary easing.

American consumers’ unprecedented retrenchment has turned the US economy’s growth calculus inside out. Consumption typically accounts for 70% of GDP (71% in the second quarter, to be precise). But the 70% is barely growing, and is unlikely to expand strongly at any point in the foreseeable future. That puts an enormous burden on the other 30% of the US economy to generate any sort of recovery.

In fact, the other 30% has not done a bad job, especially considering the severe headwinds coming from consumers’ 70%. The 30% mainly consists of four components – capital spending by firms, net exports (exports less imports), residential construction, and government purchases. (Technically, the pace of inventory investment should be included, but this is a cyclical buffer between production and sales rather than a source of final demand.)

Given the 0.7% trend in real consumption growth over the past four and a half years, the US economy’s anemic 2.2% annualized recovery in the aftermath of the Great Recession is almost miraculous. Credit that mainly to the other 30%, especially to strong exports and a rebound in business capital spending.

By contrast, the government sector has been moving in the opposite direction, as state and local governments retrench and federal purchases top out after post-crisis deficit explosions. The housing sector has started to recover over the past five quarters, but from such a severely depressed level that its growth has had little impact on the overall economy.

Given the strong likelihood that consumers will remain weak for years to come, America’s growth agenda needs to focus on getting more out of the other 30%. Of the four growth components that fall into this category, two have the greatest potential to make a difference – capital spending and exports.

Prospects for these two sources of growth will not only influence the vigor, or lack thereof, of any recovery; they could well be decisive in bringing about an important shift in the US growth model. The 70/30 split underscores the challenge: the US must face up to a fundamental rebalancing – weaning itself from excessive reliance on internal demand and drawing greater support from external demand.

Capital spending and exports, which together account for about 24% of GDP, hold the key to this shift. At just over 10% of GDP, the share of capital spending is well below the peak of nearly 13% in 2000. But capital spending must exceed that peak if US businesses are to be equipped with state-of-the-art capacity, technology, and private infrastructure that will enable them to recapture market share at home and abroad. Only then could export growth, impressive since mid-2009, sustain further increases. And only then could the US stem the rising tide of import penetration by foreign producers.

The other 30% is also emblematic of a deeper strategic issue that America faces – a profound competitive challenge. A shift to external demand is not there for the asking. It must be earned by hard work, sheer determination, and a long overdue competitive revival.

On that front, too, America has been falling behind. According to the World Economic Forum’s Global Competitiveness Index, the US slipped to fifth place in 2011-2012, from fourth place the previous year, continuing a general downward trend evident since 2005.

The erosion is traceable to several factors, including deficiencies in primary and secondary education as well as poor macroeconomic management. But the US also has disturbingly low rankings in the quality of its infrastructure (#24), technology availability and absorption (#18), and the sophistication and breadth of its supply-chain production processes (#14).

Improvement on all counts is vital for America’s competitive revival. But meeting the challenge will require vigorous growth from America’s other 30% – especially private capital spending. With the American consumer likely to remain on ice, the same 30% must also continue to shoulder the burden of a sluggish economic recovery.

None of this can occur in a vacuum. The investment required for competitive revival and sustained recovery cannot be funded without a long-overdue improvement in US saving. In an era of outsize government deficits and subpar household saving, that may be America’s toughest challenge of all.

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    1. CommentedTom Hagan

      Yet another incorrect analysis. To begin with, the housing and credit bubble did not "cause" the financial collapse.The financial collapse would have happened anyway, but sooner. The effect of the bubble was just to keep the music playing longer.

      The real cause of the collapse was that banks ran out of borrowers. Had they stopped lending when they first could not find borrowers who would pay them back, the collapse would have occurred then. Instead, they began lending money they knew was never going to be paid back, liar loans, and when these inevitably failed, the bubble they induced collapsed.

      But the bubble did not CAUSE the financial collapse, it simply delayed it.

      Neither Romney nor Obama has a fix for what ails us: insufficient demand caused by excessive inequality.

      The only thing that will fix the economy is a massive redistribution of wealth to restore demand, and then a permanent redistribution of income to prevent ever-growing inequality leading to eventual collapse, as now.

      Both Romney and Obama would lead us into the abyss, Romney a bit faster. With the program proposed by either, we are doomed.

    2. CommentedJohn A Werneken

      Vote for Romney then.

      "None of this can occur in a vacuum. The investment required for competitive revival and sustained recovery cannot be funded without a long-overdue improvement in US saving. In an era of outsize government deficits and subpar household saving, that may be America’s toughest challenge of all."

      Enough said; no progress possible with the Yuppie-Union-Ethnic wing of the Democratic Party in charge.

    3. CommentedF. W. Croft

      This article's right on the money. I'd note that, in addition to building exports, we need to work harder at attracting inbound investment. Beyond visa programs, we should probably consider something along the lines of the Special Administrative Regions that have worked in the PRC: areas such as Hong Kong or Shenzhen, where tax breaks and simplified regulation are used to attract capital and stimulate new business production. Paul Romer has suggested that a related approach be used in the US...

        CommentedPaulo Sérgio

        Can Right-to-work states be considered Special Administrative Regions against the mostly unionized northern states and California? It may then just require a concerted effort to position these states more favorably..

    4. CommentedProcyon Mukherjee

      Prof. Roach is absolutely right about the shift in focus to the other 30% as consumption is most likely to stall not only for the reasons sited but also for the demographic shift as the baby boomers approach retirement when savings more than consumption would be the natural fall out.

      But the problem with growth in capital spending is better observed in the slowdown of the same in S&P 500 in Q2 (5.6%) against 8.6% last year, as forward orders in capital equipment is showing a grim picture, which impacts the forward earnings and we see manifestations of this in the guidance statements. This normally moves to cost cutting responses for a majority, not the ideal for restoring the economy to the trajectory of growth.

      Procyon Mukherjee

        CommentedDavid Cearley

        I'm not sure consumption will fall much as boomers age. Take a look at the data from a report on boomer consumption;

        Consumers ages 47 – 66 (Baby Boomers) Facts:

        Control 70% of US disposable income
        Dominate 119 out of 123 CPG categories
        40% of customers paying for wireless service
        41% own Apple computers
        53% are on Facebook
        40% most likely to use an iPhone
        Over age 50 spend $7 billion online annually
        Purchase 62.5% of new cars
        Purchase 80% of luxury travel
        70% show up to vote in elections
        Boomers spend more money each month on technology than Gen X or Gen Y – an average of $650 per month
        Spend most on health care
        Spend most on pharmaceuticals
        One in 7 boomers care for a parent or family member
        71% of Boomers go online every day
        66% of Boomers send text messages

        Read more:

    5. CommentedZsolt Hermann

      Although the facts are all around us, even within this very article we still do not want to see it.
      The main problem is the excessive consumerism, an economic model that is based on constant quantitative growth, overproduction and over consumption of products we do not have a natural desire or need for, but a sophisticated marketing machinery and the subsequent social pressure forces us to keep buying them. As a result we all delved into deeper and deeper debt, we are unhappy and increasingly empty as we stuff ourselves with thing we do not need and we have no time to deal with things, health, family, proper education, real human connections, we should be dealing with and which things could make us truly happy.
      We still stubbornly, desperately try to rescue this fading and collapsing system instead of being happy that we are liberated from this unnatural and artificial consumer system, and that we got a chance again to return to a happy, normal, natural human life in the 21st century.
      If we lived within, and adapted to the natural laws governing our vast natural, integral system this planet still has enough bounty to supply double the present human population.
      Only we need to change our attitude and lifestyle.

        CommentedMelanie holzman

        Give it a rest, Mr. Hermann.

        You have made the same comment over and over. I, for one, do not want a philosophy of what YOU think is absolutely necessary forced on me.

        CommentedLinda Narbonne

        True. We must adopt new values and lifestlye, clarify the meaning of our life; a mutual paradigm and attitude as humans living together as one united entity in mutual care.

        The crisis is our opportunity to make that shift.

        "People only accept change when they are faced with necessity, and only recognize necessity when a crisis is upon them." — Jean Monnet

    6. CommentedJim Nail

      A clear summary, but there is one little word that gets insufficient attention in it: the word 'net.' Roach emphasizes exports as a growth engine, forgetting that the word in the economics books is 'net exports.' A difference with huge policy implications. Trade controls or other measures restricting imports from China, until something happens with their currency, would be just as effective in raising net exports as as, say, extra sales of high-tech weaponry to Saudi Arabia...

    7. Commentedjracforr jracforr

      Maybe we can combine two of America's problems and arrive at a solution to this problem. Firstly many companies are said to have stashed billions in off shore tax shelter to avoid the IRS and secondly infrastructure cost and import / export tariff undermine industrial competitiveness . Many foreign nations create FREE ZONES where taxes and tariff and other hindrance to competitive industrial production are eliminated. The only stipulation is that the goods produced in these zones are for export only. This concept could be used in in the USA equally well in Southern Florida , Texas, California etc. The TAX FREE INCENTIVE that these free zones offer, should attract capital held in off shore tax haven as well as solve the " profound competitive challenge " that America suffers.

    8. CommentedRichard Foosion

      >>That is both logical and rational – and thus not something that the US Federal Reserve can offset with unconventional monetary easing.>>

      The conclusion does not at all follow from the premise. For example, if the Fed could induce higher spending, consumers would have more income and more to money to use to pay down debt (on a macro level, spending equals income). Merely increasing inflation to target or higher would reduce the real burden of debt