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."

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.

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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