by Frank Thomas
Parts I & II can be found here.
Deficits, Debt and Savings Impact on Growth
My concern is our GDP growth rate is far too dependent on a 70-72% of GDP consumption level in a society that has experienced a 30 year trend of stagnant wages for the bottom 80% of households and a steady 30 year decline in the rate of job growth due to rapidly changing technology, automation, robotization, outsourcing, job downgrading. Given these developments, our paradigm of promoting high consumption, inevitably made worse by consumer over-leveraging and weak regulatory credit standards, results in an ever increasing demand for relatively inexpensive foreign goods and services as well as foreign capital. This in turn expands trade deficits, absorbs national savings, and expands foreign debt.
I believe this is no longer, if it ever was, a sustainable approach to achieving stable GDP growth rates of at least 3% annually. Stagnant wages and consuming at 70-72% of GDP automatically leads to declining saving rates. Decreasing or depleting middle-class household savings is NOT a sustainable way to create stable, long-term growth patterns. The most threatening hurdle to coming out of this economic quagmire is the disastrous unemployment and underemployment of +-28 million Americans – over 60% unemployed or underemployed for 6 months or more. And those fortunate to get a job in these times must accept substantial wage cuts. This structural jobless growth and job downgrading is contributing in a big way to our budget deficits (and the prevailing national mood of financial insecurity) … budget deficits that also tend to accelerate trade and current account deficits.
After tax household income is about 75% of GDP. Thus, a household savings rate now of 6% is just 4.5% of GDP. Adding in corporate savings averaging 3% of GDP brings total private savings to +-7.5% of GDP (vs. almost double that in mature EU countries). A CBO study projects that U.S. budget deficits will average 5.2% of GDP over the next decade and 5.5% thereafter – leaving a net private savings rate of +2.5%. This borrowing level exhausts our modest savings and means that the U.S. has a continuing need for large foreign capital inflows to finance business investment. In contrast, prior to the early 1990s, household savings in excess of 8% of GDP plus corporate savings were sufficient to finance most business investments in plant, equipment and housing.
The high consumption-low savings-stagnant wages paradigm in combination with high budget deficits compounds the dependence on foreign borrowings as trade and current acccounts deficits rise to new risk levels. This is because domestic demand (under this paradigm) exceeds domestic output. The shortfall has to be met by imports, i.e., higher trade and current account deficits. The demand on the world’s credit caused by foreign borowings cannot be met by savings, nor are savings adequate to fund private investment. This is poignantly evidenced by a 40 year non-investment in decayed infrastructure and sub-par educational systems. (Of course, 5.5% of GDP Defense spending has also played a major role inducing deficits and choking off societal investment's role ). A recent CBO study concludes that our continuing budget deficits will transfer more and more U.S. income to the rest of the world the next decade, further eating away the living standard of middle-class Americans.
While trade and current account deficits have dropped from a peak of 6% of GDP in 2005 to 4.5% today as a result of the recession, most economists see this reversing in the intermediate term as consumption rises. I don't think this necessarily also means household savings will decline to pre-crisis lows of less than 3% of GDP to help spur consumption back to 70-72% of GDP. The great recession caused an enormous loss of middle class wealth, broad- scale structural joblessness, related considerable household insecurities, home foreclosures, deleveraging, and tougher credit terms. I feel all this will motivate middle-class Americans to stay in a stronger savings mode for some time. So I'm in the camp of those like Martin Feldstein who believe household savings will climb back to ±8% of GDP. A possible reduced consumption in the range of 65% of GDP could occur, stabilizing trade /current account deficits providing the dollar’s value remains weak, making exports more attractive to foreign buyers.
Obama's emphasis on exports rather than consumption is wise policy. But it won't work well until decent wages and jobs come back for working Americans. In the past, stagnant wages/salaries have driven the middle class to buy cheap imports with the domino negative deficit/debt effects. Sustainable job stimulus and training, balancing the budget in good times, encouraging greater savings (despite negative short-term effect on consumption) are the most reliable ways to stabilize U.S. foreign deficits and debt. Some related financial rules should be: net annual debt buildup not to exceed annual GDP growth; combined trade and current account deficits not to exceed 3% of GDP, as recommended by Paul Volcker; and budget deficits not to exceed 2% of GDP.
The latter also means, as noted above, the dollar's value must remain low to make U.S. products and services more attractive to foreign buyers and ultimately more attractive to U.S. buyers.
I am not saying higher savings are the cure-all to the multi-faceted economic mess we are in. They are a critical Part-Cure. (Some are saying a VAT will stimulate more savings and substantial tax revenues. But this gives the anti-tax cult a brain hemorrhage). Our low savings rate has forced us to be far more dangerously dependent on funds from abroad. According to Martin Feldstein, such funds have been financing more than 75% of U.S. net investment.
As stated, improving our national savings is a very important Part-Cure to our nation’s financial problems. Balancing the budget and controlling debt levels, investing in sustainable renewal projects are the priority needs. Seeking an economic renaissance by excessive dependence on High Consumption-Low Savings is a No-Cure approach to our problems.
In simple terms, we've got to confront the deeply rooted out-of-balance components of GDP growth in our economic model, namely excessive Consumption and Current Account Deficits that are choking Private and Public Investments … in a situation of meager net national savings, stagnant wage growth, and massive structural joblessness. The components of GDP growth are not working well together at all in our economic model:
GDP Components = Consumption plus Private and Public Investments plus Net Exports (Exports minus Imports).
The fiscal and growth strategies suggested herein and in PARTS I & II in answer to our economic breakdowns are but one citizen's challenge for America's best and brightest to get the final strategic priorities right for ALL Americans.
Frank Thomas
The Netherlands August 2011
Sources:
1) The Peterson Institute for International Economics
2) The Return of Saving by Martin Feldstein
3) America´s Saving Surprise by Martin Feldstein
4) The Dollar and the Deficits by C. Fred Bergsten
5) Recent CBO Study of Current/Projected Budget Deficits and Debt Growth
Note: Household saving is the difference between what households receive in after-tax income (including wages, salaries, fringe benefits, interest, and dividends) and what they spend on goods and services. Those savings can take the form of bank deposits (popular in Europe), purchases of financial assets such as stocks and bonds, or investments in real assets such as homes and unincorporated businesses. Contributions to individual retirement accounts (IRAs) and 401(k) plans ) as well as employer contributions to defined-benefit pension plans are also counted as household savings.
Note: EU countries spend less than 2% of GDP on Defense; have high Private Savings rates; generous social-nets; progressive tax systems, and a much, much lower disparity between high/low income and wealth classes.
