Real
economic growth was spectacular for Japan in 1960s averaging over 10% and later
4.5% over the next two decades. Living standards in Japan rocketed as
unemployment fell and disposable income rose culminating in increased
consumption. By the late 1970s 99.4% of Japanese households owned refrigerators,
more than in West Germany and France for example.
However growth slowed in 1990s, hovering above just 1% and
falling multiple times into recession in the 2000s. Deflation has led to a
large increase in people saving, since their money will be worth more in the
future, which has caused consumption to fall reducing business opportunities.
In addition, the Government has accumulated a massive debt of 220% of its GDP, its
population is aging with almost 40% of the population over 55 and real wages
are falling as well. Japan’s economy has definitely stagnated with investment,
consumption and its population all declining. Is Japan an exception or a
foretaste of what is to come?
In
Greece, the economy has shrunk by 23% since 2007. Germany, the best-performing
European nation, has had miserly growth of 0.7% over the last 6 years. Median
real income in the US is below its level a quarter-century ago and median
income for male American workers is lower than in 1970s. However, we should go
back to before the banking system collapse in 2007-8 to see the full extent of
the problems confronting these developed nations.
The
graph above shows the growth rates in the UK and US compared to the global
average. Even though annual growth rates
were relatively healthy in 2004, above 3%, the figures are below the global
average and mask underlying problems. During the period up to the crisis, expansionary
fiscal policy was adopted with the US and UK governments increasing their
spending to boost aggregate demand. However, aggregate demand still remained
sluggish even before the economic recession of 2008, where technology and
housing bubbles were widespread. The ‘recovery’ has been long and stuttering
with the UK, for instance, still failing to reach its peak output level of early
2008. There have been hugely aggressive attempts at stimulating the economy. In
the UK, the Bank of England has kept record low interest rates of 0.5% and used
non-conventional monetary policy in the form of forward guidance and
quantitative easing. Yet growth and the recovery have been reasonably weak
hinting at problems relating to consumption and investment since they account
for 70% of aggregate demand in the UK.
Firstly, to understand what is
happening with consumption, we must look at real income, which in the United
States has remained at around the same level since 1970 (graph below), which
has a direct and large impact on consumption. Stagnant wages mean there is a ceiling
on consumption, as most Americans simply cannot afford to consume more goods
and services. Of course, there is always the option of borrowing and that is
precisely what millions of Americans did resulting in household debt-to-income
ratios reaching 150% by 2007 rising from about 100% in the year 2000. This
means households owe more money than they earn therefore they will have to curtail
spending in the future and hence consumption should fall. The period leading up
to the crisis of 2008 where loans were easily acquired artificially boosted the
US economy and its consumption. This hid the problems of stagnated real wages
as people could still increase their spending relatively easily by getting a
loan from a bank.
Borrowing may have
boosted consumption in the short run but in the long run consumption would decline
since debts needed to be repaid. This
problem of a lower average propensity to consume was exacerbated by the crisis
of 2007-2008 denting consumer confidence hence making them more reluctant to go
out and spend. Households were now intent on repairing their balance sheets.
However, there is also another
reason behind this sluggish consumption. This is income inequality, which is
particularly of concern in the US where the top 5% of wage earners have taken
30% more of the total income since 1967. A growing gap is developing leaving a
huge disparity in income as shown by the graph beside, impacting consumption
since the lower income groups, who on average have a high marginal propensity
to consume, now don’t have as much money so they spend less in total. Meanwhile
the higher income groups with a relatively low average propensity to consume now
have more money saving most of it. Overall, growing inequality stunts growth
since effectively more people are spending less.
Domestic investment in human or
physical capital from firms has been on the slide with 67% of companies
admitting that they are ‘underinvesting’. This is a particular problem in the technology
industry where Apple, Microsoft and Google alone have corporate cash reserves
of $258 billion with almost no debt. This problem doesn’t only affect the USA, as
capital investment is at a 15 year low in the UK. Moreover, according to Deloitte
(professional services firm), a third of the world’s largest non-financial transnational
corporations are hoarding $2.8 trillion in cash. This could be again explained
by the lack of confidence in the economy, hence creating a fear to make
long-term investments, as there is more perceived risk for the firm. There is
no point building a factory to manufacture your goods if nobody is able or
willing to buy them.
However, the graph above does demonstrate that firms
started to hoard cash well before the financial crash of 2008. US non-financial
companies’ cash and liquid assets rose in real terms from $700 billion in 1990
to over $1,600bn by 2004. This surely means that short-term confidence concerns
cannot be entirely to blame and there must be some other issues within the
economy.
Tax regulations disincentivize companies to bring back the
profits earned abroad. They will be taxed (up to 35%) on it therefore they stick
it in a bank abroad (60% of American corporate cash piles are offshore).
Moreover, technology companies in particular don’t offer dividends on their
shares. They believe it would appear like they were failing to grow as a
business having to appease shareholders by giving them dividends. This in turn
again results in less money flowing back into the economy with corporations
just deciding to sit on the cash. These factors mean that investment will
continue to fall and stagnate until the Government brings about some sort of
regulatory change.
In
addition, banks will not lend to businesses owing to the banks’ large debts,
this means that there are fewer fundable investment projects. Moreover, firms
that can afford to invest through retained profit, want to see banks taking the
lead through lending, thus stimulating the economy reducing the risk of
investing.
Consumption and investment in the advanced economies of the
UK and US have been in decline even before the crash in the late 2000s. The
crash merely put the issues into stark relief and highlighted the underlying
problems that had started to brew in the previous century. This means growth
will be limited in the future and therefore the economy will continue stagnate
especially since government spending cannot make up constantly for the shortcomings
of both consumption and investment.
Government spending, both as a part of GDP and as a total,
is rising quickly. In the UK, government spending as a percentage of GDP has
more than doubled since 2007. In the US, government spending has risen by 100%
as a total from 2007. However, the governments recognise they cannot continue
in this fashion with David Cameron, for example, deciding to adopt austerity
measures to combat the growing debt and budget deficit. Many governments tried
to save the banking sector; the Irish government guaranteed it entirely putting
itself on the verge of bankruptcy, so now it cannot possibly adopt expansionary
fiscal policy to manipulate aggregate demand.
This means that government spending
cannot prop up aggregate demand and the worst effects of stagnant consumption
and investment may yet be felt. There is definitely a huge amount of evidence
indicating that nations like the UK and the US are in for a prolonged period of
economic stagnation. But is it all doom and gloom? Is there anything that could
stave off economic torpor?
According
to a classical economic view, the economy should sort itself out without
intervention. A deprecation in the currency would make the countries exports
more price competitive and imports more expensive. In the long run, the current
account would improve by building surpluses thus boosting aggregate demand,
increasing confidence as firms are selling more of their goods. They therefore
believe there is more demand in the economy, so are more likely to invest. This
then impacts AD again and causes a multiplier effect as firms start to increase
their output, they hire more workers paying them wages, who then can afford to
consume more goods, in turn leading to more output.
Moreover, an economic downturn
should lead to nominal wages falling as there is less demand for goods and
services and therefore less derived demand for labour. Prices would fall
restoring the demand within the economy. The fall in wages and currency deprecation
should restore the economy to its original position…in theory.
However,
Britain for example is still running current account deficits year on year
despite a depreciated pound, most recently at 3.8% of its GDP in late 2013. The
USA is not exempt either with a deficit of above 2.5% of GDP. This can be
explained by the types of goods the UK and the USA imported and exported. As
the economies develop, their products become more sophisticated. Therefore
their main trading partners are also advanced economies, since they are the
ones that can afford and require them. The USA exports almost 20% of its goods
to Canada and the UK’s top 5 trading partners are all advanced economies. If
the consumers of the exports are in a bad economic situation, it would require
a massive depreciation in the currency to stimulate any sizeable increase in
exports.
To make matters worse the imports
are price inelastic, since they are often related to energy requirements. Crude
oil alone accounts for 8.8% of American’s total imports. This is such an
important product nowadays, needed for fuel, energy and chemicals, that it is a
necessity and even if crude oil does become slightly more expensive, it will
continue to be bought. This exacerbates the current account deficit by
increasing the cost of imports whilst exportation remains stable. In addition,
the Eurozone, comprising of 18 countries, cannot have this natural depreciation
since they share the same currency.
Moreover, as Keynes pointed out,
wages are sticky downwards especially in the advanced economies as workers are
not willing to receive lower wages. Therefore the self-stabilising mechanisms
do not work in the advanced economies adding strength to the idea of
stagnation.
From
the information above, it appears the balance of payments won’t lead the
advanced economies out of stagnation and into a new era of reinvigorated
growth. However, there is a revolution on the horizon brewing in America where
‘fracking’ is tacking centre stage in the energy market. Hydraulic fracturing
or ‘fracking’ has made oil and gas reserves, previously not viable to extract,
obtainable. The US Energy Information Administration has forecast record levels
of oil output of 9.6 million barrels per day. This has driven the trade deficit
to a 4 year low and is expected to continue to fall, as imports are to meet
only 24% of the US fuels demands by 2015 down from 60%.
Now, major banks like JPMorgan are
expecting higher growth than forecast, 3.3% rather than 2.4%. In addition,
‘fracking’ has kept the price of oil, gas and therefore energy in the US low
compared to the rest of the World. For example, propane (product of refining
crude oil) is only $620 a tonne in the US compared with over $1,000 a tonne in
China. This has an effect on both households and firms.
Households have benefitted from
‘fracking’ as their energy bills have stayed constant and even fallen.
Households in some states, Ohio for example, would have paid up to 129% more on
their gas bills if it wasn’t for this drilling boom. More disposable income
combined with a new sense of confidence due to higher growth forecasts may
stimulate consumption. Increased demand may provide companies with
encouragement to invest in capital to meet the increased demand, starting a
cycle of growth that would definitely help to solve the stagnation issue.
Moreover, lower energy prices help
firms in a more direct manner reducing their costs of production and therefore the
price. If the quantity demanded rises for their goods or services, this may
give companies the confidence to invest as they have seen that there is
actually demand within the economy. Firms may start to employ more people,
increasing the number of people with disposable income, which could cause
consumption to rise as well.
The American economy may still
recover and escape from the jaws of stagnation through an energy revolution.
However, it begs the question whether the other advanced economies will also
return to plentiful growth?
A
resurgent USA will probably lead the advanced economies out of stagnation,
since America is so vital to the World economy. They are hugely important in
the context of trade because they are large trade partners with many of the
developed nations. The US accounts for over 10% of British exports, 8% of
German exports and 18% of Japanese exports highlighting that the US is the cog
that turns the machine of international trade. If America starts to import
more, the effects may be monumental on other developed countries, both in terms
of business but also it stimulates confidence within the other economies, which
has been so lacking over the last 6 years.
In
conclusion, the private sector, firms and households, have built up a lot of
debt during the last decade and according to the economist Hyman Minsky, a debt
crisis takes a long time to get resolved. People and firms are not willing to
spend until their debt is removed completely. Of course, there are other issues
such as motionless real wages and trade, that doesn’t follow classical economic
thinking, making stagnation more likely. The seismic event in the American
energy market of ‘fracking’ may spark a period of prosperous growth. Moreover,
the parallels with Japan are tenuous, as they have very little immigration and
an aging population compared to the younger, multi-cultural areas of Europe and
America. However, stagnation does seem to be engulfing the advanced economies
and no Government is at the moment successfully combating it. There is no real
evidence that suggests an economic recovery is on the cards and most of
arguments against stagnation are speculative. An economic resurgence hinges on
America, but most of the evidence does point to the depressing prospect of
stagnation.
Bibliography
- · CIA Factbook
- · World Bank
- · ‘Japanese Industrialisation and its Social Consequences’, Hugh. T. Patrick and Larry Meissner
- · Organisation for Economic Co-Operation and Development
- · US Bureau of Labor Statistics
- · US Bureau of Economic Analysis
- · rwer.wordpress.com
- · Financial Times: ‘How to spend $2.8tn of corporate cash’ by John Plender, 2014
- · Financial Times: ‘US Oil Boom drives trade deficit to four-year-low’ by James Politi and Ed Crooks, 2014
- · Eurostat
- · ‘The Road to Recovery: How and Why Economic Policy must change’ by Andrew Smithers, 2013
- · Office of National Statistics
- · GOV.UK
- · The Economist: ‘The Fed discovers Hyman Minsky’, 2010
