11 February 2010

The myth of the decline of the US consumer
A widespread myth about the international financial crisis is that what is taking place is a serious reduction of consumption in the US, with the knock on consequences that would flow from this for the world economy. The present article shows that this myth is factually untrue. No major downturn of US consumption has taken place. Therefore such a non existent downturn in US consumption cannot be the driving force of either the US or international Great Recession . * * *

The claim that a key driving force of the present international 'Great Recession' is a major downturn of US consumption is a frequent one. We will take as an example of this argument Stephen Roach s book The Next Asia - all page references therefore refer to this work. Roach, president of Morgan Stanley Asia, is chosen because he is a coherent economist who spells out this mistaken claim more lucidly than ma ny far less serious economists who make it. According to Stephen Roach what is taking placed is the 'capitulation' of the US consumer. Thus Roach refers to, America s postbubble compression of consumer demand. (p378). This alleged reduction in US consu mption is then cited as the driving force of the economic downturn. As Stephen Roach put it: The current recession is all about the coming capitulation of the American consumer. (p20) Therefore: The main event is the likely capitulation of the overextend ed, savings-short, overly indebted American consumer. (p42). Roach concludes that: After a dozen years of excess, the overextended American consumer is finally tapped out Hit by the triple whammy of collapsing property values, equity wealth destruction, and an ongoing unemployment shock. (p325) As a result of this situation a major reduction in the share of consumer spending in the US economy is foreseen. Stephen Roach concludes: the US consumption share of real GDP, which hit a new record of 72.4% in t he first quarter of 2009, needs, at a minimum, to return to its prebubble norm of 67% ... the die is cast for a protracted weakening of the world s biggest spender. (p32) The situation is therefore that: the US consumer [is] most likely in the early stages of a multi-year contraction (p79) Indeed: Despite the unprecedented contraction of consumption in late 2008, there is good reason to believe the capitulation of the US consumer has only just begun. (p385) It is this alleged reduction of US consumptio n which, it is asserted, will cause the slowdown in the world economy: The postbubble shakeout stands to be dominated by a protracted adjustment of the US consumer providing powerful and lasting headwinds on the demand side of the global economy for yea rs to come.' (p396) The problem for this thesis is that it is factually incorrect. No such major reduction of US consumption has taken place. The share of consumption in US GDP has expanded and not

contracted. And, as no significant reduction of US consum ption has taken place, it therefore cannot explain any of the current trends in the world economy To show the factual situation Figure 1 graphs the percentage change in the major components of US GDP between the 2nd quarter of 2008, the last before the US recession began, and the most recent available data - that for the 4th quarter of 2009. During this period US GDP contracted by -1.9%. However the reduction in US personal consumption was only -0.6%. Government expenditure, consumption and investment taken together, increased by 3.1%. Compared to the relatively small fall in US personal consumption the really large declines were in US residential fixed investment, which dropped by -21.2%, and in US non -residential fixed investment, which declined by -20.3%, In other words, as regards the US domestic economy, what occurred was not a consumer decline but a large investment fall. As regards the external relations of the US economy there were also declines in exports, down -7.7%, and a major drop in imports - by -12.3%. Compared to these major shifts in investment and trade the decline in US consumption was extremely small and played almost no role in the economic contraction. Figure 1

To show the real shifts in the US economy even more starkly, and illust rate further that the 'decline of US consumption' is a myth, Figure 2 shows the shifts in the major components of US GDP from the 2nd quarter of 2008 to the 4th quarter of 2009 in monetary terms - i.e. in current prices.

In this period US GDP fell by -$34 billion. However US personal consumption actually rose by $56 billion. In contrast US residential fixed investment fell by -$129 billion and US non residential investment dropped by -$362 billion. The total decline in US fixed investment was -$490 billion. The breakdown of these figures is important as it shows that the downturn in investment was concentrated in non -residential, and not simply residential, sectors. Over the same period inventories rose by $9 billion. Net trade, that is the trade balance, improved by $298 billion. US government expenditure, consumption and investment combined, increased by $92 billion. In current price terms, therefore, there has been no fall at all in US consumption, indeed it has increased. It is US fixed investment that has fallen sharply. Figure 2

What has made possible these shifts is that the proportion of the US economy devoted to personal consumption has not fallen, as Stephen Roach and others believed it would, but it has on the contrary increased. This is shown in Figure 3. US personal consumption was 70.3% of GDP in the 2nd quarter of 2008, immediately before the recession started, and it had risen to 70.9% of GDP by the 4th quarter of 2009. Figure 3

In summary, the claim that the 'Great Recession' is rooted in a decline of the US consumer, and of US consumption, is a myth. No such decline has taken place. The economic decline in the US is a fall in investment, not in consumption. Theories that the present situation in the world economy is driven by a decline in the US consumer and US consumption are therefore equally false. A process cannot be driven by something which has factually not occurred. A myth is not made truer by repeating it. Therefore the claim that the 'Great Recession' is rooted in a decline of the US consumer, and US consumption, should be abandoned as factually unfounded. * * * This article originally appeared on the blog Key Trends in Globalisation on 11 February 2010.

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