Relax and enjoy yourself - it's probably good for the economy
Strong domestic consumption has sustained the recovery while continenta l economies have faltered ... Rising confidence has had the effect of reducing unemployment
Tuesday 19 August 1997
That rhetoric washes across the Channel. To judge by the way the "windfall" gains that people here have received from their building society shares are discussed as a problem, and the Chancellor was criticised for not taxing them back, you might imagine that the fact that Britons are richer to the tune of pounds 35bn is somehow bad. The counter-arguments - for example, that over-investment means that savings are wasted and that for all countries to strive to be net exporters is self-defeating and ridiculous - are rarely made.
Or at least they are rarely made outside the US. One of the effects of the long American boom and the creation by the US of hi-tech industries that dominate the world has been a reassessment of the nature of the US current account deficit, and with it, an explanation of why high-consumption economies have become more vibrant than those of Germany and Japan.
The core of the argument is that the US in particular is in many ways a developing country. Other countries rush to invest there because it offers higher returns than could be obtained at home - just as Britain invested much of its savings abroad in the second half of the last century and Japan has invested abroad during the last two decades. The current account deficit that the US has been running is therefore a necessary offset to its capital account surplus.
This argument has been well put by John Makin, an economist at the American Enterprise Institute for Public Policy Research in Washington. In a paper this month he turns on its head the idea that America's main problem is its shortage of savings. If other countries want to invest in the US, the dollar would be driven far too high were it not for the willingness of US citizens to spend their money. If they did not do so, the US would have faced the same problem as Japan, which over-saves.
Oversaving creates two difficulties, both of which have struck Japan. The savings are exported in the form of foreign investment, or they remain at home where they have to be invested in something.
Foreign investment is fine if there are adequate opportunities and the investors have adequate skills. In the case of Japan much of its direct investment - investment in plant and machinery - has been well-spent. Japan owns high-quality factories throughout the rest of the world, which is admirable. But it has also invested in foreign financial assets, which have often fallen in value: it was estimated that Japan has lost about half its accumulated current account surpluses through bad investment.
When savings are invested at home, unless there are adequate opportunities, the effect is simply to drive up the exchange rate and drive down the domestic rates of return on investment. That is what has happened in Japan. The non-manufacturing sector remains heavily regulated and accordingly there is little incentive to invest to improve productivity. These non- manufacturing industries would not be exporters - they would have to live on domestic demand - but if they were really successful, that would stimulate domestic demand, and might even eliminate the current account surplus. Japan does not want to risk that, so despite the modest deregulation taking place, growth will remain stagnant.
The US shows the reverse phenomenon. Because it is a developing country, it is normal and natural to attract foreign capital and to run a current account deficit. The fact that the dollar has strengthened in the last year, despite the deficit, is further proof of the attractions of the US as an investment haven. Indeed had it not been for the deficit, the dollar would have soared to a level where US exports would be priced out of foreign markets (as has happened in Japan) and the country's attractions would have been weakened. Moral: it is a good thing that Americans are such vociferous consumers.
What does all this say about us? The parallel is not perfect because the UK happens to be running a current account surplus. It is true that like the US the UK has attracted large amounts of foreign capital; it has also been a large capital exporter, which has helped keep sterling at a reasonable level. But there is not quite the same perceived lack of domestic savings in the UK, though the proportion of consumption in GDP remains roughly five percentage points higher than other European economies. We are able to sustain this lower savings rate because we invest less and therefore need less savings; and partly because we can attract large capital inflows.
To some extent the UK may also be a developing country, but it is not quite in the same league as the US. Nevertheless it is possible to make a case that the fact that the urge to splurge is good. The fact that once Britons have money in their pockets and purses they will go out and spend it gives a strength rather than a weakness to the economy. Strong domestic consumption has sustained the recovery while continental economies have faltered. This has enabled the country to head into a virtuous circle, with strong consumer confidence bringing unemployment rates to less than half those of France, Germany and Italy, while falling unemployment has further boosted confidence. The high propensity to consume, plus lower taxation, means the UK's living standards are comparable to those of France, Germany and Italy despite the fact that GDP per head is lower.
Further, relying on domestic consumption to sustain demand is in some ways a safer strategy than relying on exports where the growth of demand for your products is beyond your control.
As with all economic arguments, it would be silly to push this one too far. At some point excessive consumption leads to a surge in imports and becomes unsustainable. The question for both Britain and the US is whether the economies are close to that point where most additional demand cannot be met by higher production at home and the pressure shows by sucking in more imports and by rising inflation at home. But to say that is simply to point out there is such a thing as excessive consumption. There can be too much of a good thing. But to regard consumption as somehow bad and investment (however poor the quality) as good, is absurd. There is nothing wrong with people enjoying themselves.
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