The trouble with the recovery is that it has so far been supported almost entirely by government stimulus. Whether it is lending by state-owned banks in China or a cash-for-clunkers programme in the US or lower excise duties and low interest rates boosting automobile sales in India, economists are holding their breath wondering whether the private sector will take over when the government starts withdrawing its stimulus measures. Nobody expects the US consumer to re-assume his role of Titan holding up the world economy. He has already started to spend less and save more. But how much more will he save? That’s the question that IMF economists Jaewoo Lee, Paul Rabanal and Damiano Sandri attempt to answer in their IMF Staff Position Note on US Consumption after the 2008 Crisis.
The authors point out the crucial role the US consumer plays in the world economy. They write: “If US private-sector demand remains at a subdued level, global economic growth will be less vigorous than otherwise, and the distribution of current account balances will need a realignment—a smaller deficit in the US will have to be matched by smaller surpluses or larger deficits in other countries.”
US household consumption has already declined, with consumption as a percentage of income declining from the pre-crisis high of 95% to 92% in 2009. US household wealth has fallen sharply as a result of the crisis and credit availability has tightened. The US potential growth rate too has been revised downwards as a result of the crisis, from 3% in the late 1990s to about 2% over the medium term.
Illustration: Jayachandran / Mint
After running a series of simulations, the researchers conclude, “We expect the US consumption to remain at a relatively subdued level over the next several years, with the household saving rate settling at 5–7% of disposable personal income, somewhat above the 2009 saving rate of nearly 5%. Though the estimate is subject to a sizable statistical uncertainty, it is supported by several alternative estimates and simulation analysis. Compared to the pre-crisis years (2003–07), the estimated changes in saving and consumption imply a decrease in the US private sector demand of 2–3.75 percentage points of GDP (gross domestic product)—close to a half of the US current account deficit at its peak. This will have substantial effects on global economic development after the current crisis.”
In short, other countries will have to adjust accordingly, most importantly export-driven economies such as China, Japan and Germany.
China: Does Government Health and Education Spending Boost Consumption?, by Steve Bartnett and Ray Brooks, IMF Working Paper
The problem for China is exactly the opposite of that in the US. The Chinese save too much and consume too little.
Researchers have often linked high Chinese savings to the precautionary motive since there are no social safety nets, or rather since the “iron rice bowl” of the socialist years has now been taken away, Chinese savings have increased, so goes the argument. Bartnett and Brooks look at the data on Chinese consumption and find that the share of household consumption has been falling over time. They point out that in addition to a higher savings rate, the decline in the household share of consumption is also because income at homes as a share of GDP has been falling—households are getting a smaller share of the increase in the economic pie. Say the authors: “For urban households, roughly 60% of the decline in consumption since the early 1990s is attributable to a drop in disposable income as a share of GDP. For rural households, falling income plays a larger role and explains around three-fourths of the decline since the early 1990s.”
Illustration: Jayachandran / Mint
How could this be rectified? Other economists have noted that the very low rates of interest on deposits allow lending rates to be kept low, implying that households are subsidizing companies and exports. Bartnett and Brooks find that higher government health spending will reduce the need for people to save, thus increasing consumption. They add: “The magnitude of the impact, moreover, is quite large and suggests that each additional yuan in government health spending boosts urban consumption by two yuan.” Higher government spending on education, however, has no impact on consumption.
With the export-led model of growth in jeopardy as the US consumer slows his consumption, China has no alternative but to increase domestic consumption. Putting a social safety net in place will help people feel secure enough to start spending.
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