MILAN – As the American economy continues to sputter three years after the global financial crisis erupted, one thing has become clear: the United States cannot generate higher rates of growth in GDP and employment without a change in the mix of the economy’s domestic and export-oriented components. Above all, this will require structural change and greater competitiveness in an expanded tradable sector.
For more than a decade prior to the crisis that began in 2008, the US economy fueled itself (and much of the global economy) with excessive consumption. Savings in the household sector declined and leveled off at about zero, as low interest rates led to over-leveraging, an asset bubble, and an illusory increase in wealth.
Government, too, dissaved by running deficits. Overall, the US economy expended more than it generated in income, running a trade (more precisely a current-account) deficit, and borrowed the difference from abroad. Both household and government spending patterns in relation to income were unsustainable.
With more than ample domestic demand, considerably boosted by rapid expansion in government and health care, the US economy sustained growth and employment in the face of large increases in the labor force (27 million new workers since 1990), notwithstanding the substantial headwinds created by new labor-saving information technology. Setting aside financial sustainability, the most worrying aspect of the pattern was distributional: very low wage growth in the middle-income range.
Moreover, with excess reliance on domestic demand, the structure of the US economy evolved with a bias toward the non-tradable sector (where all of the new jobs were created) and insufficient reliance on foreign demand and hence exports. That led to income and price movements that caused the tradable sector’s scope to shrink, as lower value-added links of global supply chains moved to emerging economies.
The financial crisis that began in 2008 caused a sudden stop to the unsustainable pattern on the demand side. Asset prices fell, households began a lengthy process of deleveraging, savings rose, and government – faced with falling revenues and rising expenditures on unemployment insurance – could not make up the difference.
But that pattern, too, is clearly unsustainable. The net effect is that domestic demand is dramatically lower, and overall demand (domestic and foreign) is too low. As a result, the US economy has almost stopped growing, particularly as the federal government (together with state and local governments) are now reining in their own budget deficits.
A large shortfall in domestic demand stymies growth and employment in the non-tradable sector, where it is the only demand that is relevant. By contrast, the part of the tradable sector that responds to foreign demand can grow with emerging-economy growth. That is helpful, but the tradable sector, as it is currently configured, is not an employment engine.
Indeed, the US economy’s structural evolution over the past two decades has made additional foreign demand inaccessible without expanding the scope of the tradable sector. The excessive domestic demand that underpinned this evolution is now gone, permanently. When deleveraging in the household sector is complete, domestic expenditure may rebound, but the savings rate will not and should not go back to zero.
Fiscal stimulus, in the form of backloading deficit-reduction efforts, might help tide the economy over while structural adjustment and expansion of competitiveness in the tradable sector proceed. But, by itself, stimulus is not the answer. Otherwise, the shortfall in domestic demand would reassert itself when the stimulus ended. The argument for a measured deficit-reduction program is to buy time for the structural shifts that will expand accessible external demand and fill in the gap in aggregate demand.
What structural adjustments are needed, and how will they occur? The pace and effectiveness of structural adaptation will be determined not only by private-sector incentives and market forces, but also by government reform and investment.
With high unemployment in many parts of the labor market, downward pressure on wages will further exacerbate the country’s already skewed income-distribution. Labor markets will eventually clear, but this will happen slowly and painfully, owing to skills gaps and other short-term mismatches.
Government cannot solve the problem alone, much less make the problem go away overnight. But government can take action that improves productivity, investment returns, and conditions for innovation, thereby increasing the pace and enhancing the long-term results of structural adjustment.
To be viable, policy measures must include comprehensive tax reform; a balanced deficit-reduction program; investment in education, skills upgrading, infrastructure, and technology; and a fully developed energy policy that anticipates rising relative energy prices as emerging-market growth enlarges the global economy to three times its current size over the next quarter-century.
For maximum impact, the targeting of some of these investments should be undertaken in collaboration with the private sector (business and labor). After all, that is most often where the relevant knowledge of the best opportunities is to be found.
Finally, to attempt this rebalancing in the current fiscal environment without tax increases (perhaps temporary measures designed to overcome the cumulative investment shortfall) would be very unwise. To do so would both impede the pace of recovery and diminish the quality of the final result.