Wednesday, November 12, 2008

Recession and the pain of adjustment

I was greatly struck by some numbers John Taplin included in his post What Now? He quotes Jeremy Grantham.

An amateur economist could summarize and simplify the Chinese economy as 39-37-37: an astonishingly large 39% of the GDP is capital spending, 37% is internal consumption, and an amount equal to 37% of GDP is exported. (These numbers do not sum to 100 as we are not using exports net of imports because we are concerned with the vulnerability of total exports to a weak global economy.) The U.S., in comparison, is 19-70-13, disturbingly on the other side of normal; 70% consumption compared with 57% in both Germany and Japan, for example, and nearly twice that in China.

The position in Australia is not quite as bad as the US although, as amoranthus keeps reminding me in his comments, our consumption is 62 per cent of the economy.

I looked at some related issues in a post on my personal blog, Agriculture, the environment and Australia's future. There I said in part:

For a long time our mainly urban population has been buying more from overseas than we sell. The gap has been met through overseas private borrowing. This is not sustainable in the longer term.

We have to either increase our saving rate or, alternatively, find new things to sell internationally. If we lose our coal and agricultural exports, the position becomes much worse. Should Steve Truman's gloomy prognostication that Australia may become a net food importer prove correct, then we may find ourselves in diabolical trouble, as will those in other countries that we presently feed.

In Robert Shiller on bubbles the Australian economist Harry Clarke looked in part at the way increasing Australian asset prices concealed our low savings rate.

One of the things that it is easy to lose sight of in the current economic climate is that recession is, in some ways, the necessary corrective to periods of boom. This may be hard to accept by those who are hurt, but is still I think correct.  

During booms, inefficiencies creep into systems across all sectors because growth compensates. Booms allow us to spend more than we are in fact earning. They lead to asset prices that are out of kilter with real values. When contraction comes it exposes all these weaknesses. We are forced to adjust.

This leads me to a nagging worry about the current adjustment packages. To some degree their aim is to restore the status quo, to put us back to where we were before. This creates a number of risks.

To begin with, to the degree they work they may leave the structural imbalances in place. Because these still have to be worked through, the outcome is likely to be low growth.

They may also leave national governments encumbered with debt, limiting future flexibility.

Finally, they risk over-shooting. I have not totaled up the value of all the global support and stimulation packages, but they must run now into trillions of dollars.

The key point to remember about recession is that it frees up resources for other things. If we simply accommodate this by restoring consumption, things remain the same even if we get an immediate stimulus to economic activity.

On the other hand, if we use the free resources for investment purposes then we have assets that can generate future income.

The US has focused in many ways on attempting to protect or restore the status quo, China on future investment. Which do you think is likely to give the best result?   


Hi! I'm Grace said...

You have a great post. It pays off to everyone who visits your blog. Keep it up. :)

Jim Belshaw said...

Thank you for the encouragement, Grace.