by Elliott Morss, Morss Global Finance
Note: A version of this article was published by Deutsche Welle, 23 May 2013.
Part. 1 of this report highlighted the positions of the IMF and Europe on the austerity/growth trade-off as reflected in discussion on what to do about the problems of Greece, Italy, Portugal, and Spain. This second part examines austerity/growth perspectives in China and the US. As Table 1 makes clear, the economic situation in China and the US are quite different from the Euro countries covered in Part 1. China’s growth, although slightly less than in earlier years, remains remarkably high. The US does appear to be recovering from the global recession, albeit slowly. And even though China and the US do not have the debt and unemployment problems of the Euro countries, there is still an ongoing debate on austerity/growth in both countries.
The US: Is This the Time for Austerity in the US?
In 2009-10, the depth of the global recession with 16 million unemployed, there was widespread agreement in the US that growth trumped austerity and a stimulus was needed. Consequently, Congress enacted a $787 billion stimulus package. But Congress has been unwilling since then to pass any significant stimulus bill, even though the economic recovery has been slow.
There were several reasons for not further Congressional action:
- Republicans stated objective: block all Obama initiatives;
- A debate over the size and role of government:
- Republicans favor lower taxes and expenditures
- Democrats support higher government investment outlays and higher taxes on the rich, and
- Others worry about the growing government deficit.
With further Congressional action blocked, fiscal policy (higher government expenditures, lower taxes) was no longer available as a tool to stimulate the economy.
However, Ben Bernanke took over for Alan Greenspan as the head of the Federal Reserve in 2006. Much of his research had been on just how long it took the world to recover from the ’29 global recession. To avoid a repeat of the slow ’29 recovery, he believed vigorous government stimulation efforts are needed. And with additional fiscal stimulatory efforts blocked, Bernanke said he would do all he could to stimulate the economy. And he has: since 2008, the US money supply (M1) has increased by 76%. And the Fed has kept interest rates near zero.
Arguments Pro and Con
Perhaps the most convincing argument for growth/continuing stimulus has been made by Joe Stiglitz, a Nobel Prize winner and a former VP and Chief economist of the World Bank. After observing that the US recovery remains “anemic”, he says:
“The risks are asymmetric: if these forecasts are wrong, and there is a more robust recovery, then, of course, expenditures can be cut back and/or taxes increased. But if these forecasts are right, then a premature “exit” from deficit spending risks pushing the economy back into recession.”
It is notable that the IMF, after the Greece fiasco, is supportive of the Stiglitz position. After reviewing the US situation, the IMF staff recently concluded:
“The recovery continues to be tepid, employment remains well below pre-crisis levels, and the housing market is stabilizing but is still at depressed levels. Fiscal deficit reduction should proceed at a measured pace, to avoid undermining the fragile recovery. Monetary policy remains appropriately accommodative, with room for some further easing if the outlook were to deteriorate. More resources should be devoted to active labor market policies, including those aimed at the long-term unemployed, to prevent long-term unemployment from becoming structural. Further monetary easing may weaken the U.S. dollar, but would have positive spillovers from strengthening the U.S. economy and hedging against downside risks.”
The Fund mentions “further weakening of the US dollar”. To put this in perspective, the dollar has weakened 28% in value against the dollar since the Eurozone came into being in 1999. That was very helpful. It has allowed the US to remain competitive with Japan. Since the “weak sisters” in the Eurozone do not have their own currency, they cannot use an exchange rate adjustment to stay competitive on world markets.
But overall, unlike what is happening in Europe, there is general agreement on what is needed to resolve the twin concerns: a stimulus was needed to get the economy going and now a plan to curb the growing deficit should be put in place. The only issue now is when and how the deficit cutting should start. In actual fact, it has already started with the ending of the payroll tax holiday and the beginning of the “Sequester”. The Congressional Budget Office estimates the sequestration will reduce government outlays by $100 billion in 2013 and 2014. The Congressional Research Service estimates that ending the payroll tax holiday and other tax changes will mean tax increases of $400 billion in 2013.
b) Pro-Austerity/Deficit Reduction
As indicated above, the supporters of austerity include groups that want to reduce the size of government and those who are seriously concerned over growing debt. Their cause got a boost when Harvard professor and ex-IMF economist Ken Rogoff teamed up with Carmen Reinhardt to write “Growth in a Time of Debt”. The findings have been taken to mean that when the debt to GDP ratio of a government exceeds 90%, GDP growth slows down. While the study has been largely discredited by other scholars, see e.g. Robert Huebscher, because of statistical errors and questionable country groupings, the book did provide support for the pro-austerity advocates.
But the debate in the US is quite different then it is in Europe. In the US, both growth and austerity supporters agree that at some point, the focus should turn to deficit reduction. In fact, President Obama appointed Alan Simpson (Republican) and Erskine Bowles (Democrat) to head up a commission intended to find the best way to end the deficit. The National Commission on Fiscal Responsibility and Reform (the Simpson-Bowles report) recommended reducing the federal deficit by nearly $4 trillion and eliminating it by 2035. Outlays would be reduced from 24% of GDP in 2010 to 21% in 2035 while revenues would rise from 15% in 2010 to 21% in 2035. In addition, the report called for significant health care and social security reforms. And while the report was not signed by the 14-vote threshold of commissioners required to formally endorse the blueprint, the report provides all the information needed to end the deficit using different approaches.
China: A Different Type of Austerity/Growth Debate
Table 1 indicates that China is very different position than Europe or the US: rapid growth, low unemployment, and low debt. But it also is facing growth/austerity issues: they are just longer-term. For the last two decades, China’s amazing growth has been fueled by exports to the West. And in recent years, as export growth has slowed, the government has launched major infrastructure programs for roads, railroads, and energy. And at the same time, the private sector has supported huge urban real estate developments. The result has been a 52% investment rate. Perhaps austerity in China should be measured by it consumption rate of only 48% of GDP.
Until the mid-‘90s, the Chinese government made it very difficult for citizens to move from rural to urban areas. These policies were then relaxed (in part to supply the workers needed for the explosion in urban real estate development). The result has been a rush to urban areas. Since 1990, the China’s workforce has grown by 25%. In that same period the urban population has more than doubled, growing from 300 million to nearly 700 million.
The “growth” question in China is where future jobs will come from. Exports are no longer generating new jobs, urban real estate development is slowing, and how much more infrastructure investment makes sense? The hope is that demand from the growing middle classes will pick up the slack – less austerity.
But here is the rub: much of the demand from the growing middle class will be for Western products. And this is the point at which discussions of austerity start. China is a resource poor country. Iron ore is good example. Unlike the US that makes all the new steel it needs from scrap, China needs to import iron ore to make steel. Energy is another case where China is resource poor. Since 1995, Chinese energy imports are up 13 times to 16% of total imports. Commodities have increased 17 times to 23% of total imports. 53% of China’s energy imports are for oil, and oil imports will continue to grow: China’s middle classes want autos and other import intensive consumer goods.
Consider autos, a product that the Chinese middle class wants. In the US, there are 802 motor vehicles per thousand people. It is interesting to ask what will happen to oil consumption when there are 400 motor vehicles per thousand people in China. That would mean more than an eightfold increase in Chinese vehicles. Assume they drive the same distances as the current vehicles and are powered by and get the same miles-per-gallon as the current vehicles. This would cause Chinese auto fuel demands to increase by almost 9 times. That growth would increase global oil demand by 77% over its current production level. This will not happen. Something has to give.
In March of this year, China ran $800 million international trade deficit. OK. So while FocusEconomics predicts a $248 billion trade surplus for 2013, China is changing. China’s demand for foreign goods is growing. At the same time, rising labor costs are reducing export margins ….
Would lower growth help? Consider the IMF’ judgment:
“The economy seems to be undergoing a soft landing, though global headwinds are increasing. Growth is expected to moderate to around 8 percent this year and inflation to drop to 3½ percent. Meanwhile, a political transition is underway. The economy has been slowing partly as a result of policy action to moderate growth to a more sustainable pace, but a worsening of the euro area crisis poses a key risk to the outlook.
China’s growth has become increasingly dependent on investment, a pattern that will be difficult to sustain. Therefore, there is a need to accelerate progress in transforming the economic growth model to be more reliant on consumer demand. Such a transformation would substantially boost living standards and make growth more balanced, inclusive, and sustainable.”
In other words, less austerity.
An austerity/growth debate is happening in China and the US. But it is quite different than what is being discussed in Europe. Austerity in Greece and Spain has caused overall unemployment rates to approach 30%, with unemployment rates of young people exceeding 50%. And yet the Germans continue to push austerity. It appears the IMF has learned its lesson: it is calling for stretching out government deficit reduction periods and lower debt (presumably via defaults – not something the European banks want to hear).
The US is different: while there are political blockages, the austerity/growth trade-offs are clearly understood. And assuming the recovery stays on track, the focus on reducing the government deficit will gain momentum in the next few months.
Looking at China from a Western perspective, things look great: should the GDP growth rate be 8 or 10%? But there are clouds on the horizon. Will its huge trade surplus of recent years of recent years turn negative? And if so, will it be forced to borrow huge sums internationally to finance its imports?
And then there are the growing energy needs. Global warming will get much worse as both China and India burn all the fossil fuels they can obtain to satisfy the energy needs of their more than 2 billion citizens.