Wednesday, August 1, 2012

America's Other 30%

The American consumer is but a shadow of its former almighty self. Personal consumption in the United States expanded at only a 1.5% annual rate in real (inflation-adjusted) terms in the second quarter of 2012. Unfortunately, it continues a pattern of weakness that has been evident since early 2008.

Never before has the American consumer been this weak for this long.

The cause is no secret. Consumers made huge bets on two bubbles – housing and credit. Reckless monetary and regulatory policies turned the humble abode into an ATM, allowing families to extract dollars from bubbles and live beyond their means.

Both bubbles have long since burst, and US households are now dealing with post-bubble financial devastation – namely, underwater assets, record-high debt, and profound shortages of savings. At the same time, sharply elevated unemployment and subpar income growth have combined to tighten the noose on over-extended consumers.

As a result, American households have hunkered down as never before. Consumers are diverting what little income they earn away from spending toward paying down debt and rebuilding savings.

Consumption typically accounts for 70% of GDP. But the 70% is barely growing, and is unlikely to expand strongly at any point in the foreseeable future. That puts an enormous burden on the other 30% of the US economy to generate any sort of recovery.

The 30% mainly consists of four components – capital spending by firms, net exports (exports less imports), residential construction, and government purchases.

Given the strong likelihood that consumers will remain weak for years to come, America’s growth agenda needs to focus on getting more out of the other 30%.

The other 30% is also emblematic of a deeper strategic issue that America faces – a profound competitive challenge. A shift to external demand is not there for the asking. It must be earned by hard work, sheer determination, and a long overdue competitive revival.

On that front, too, America has been falling behind. According to the World Economic Forum’s Global Competitiveness Index, the US slipped to fifth place in 2011-2012, from fourth place the previous year, continuing a general downward trend evident since 2005.

The erosion is traceable to several factors, including deficiencies in primary and secondary education as well as poor macroeconomic management. But the US also has disturbingly low rankings in the quality of its infrastructure (#24), technology availability and absorption (#18), and the sophistication and breadth of its supply-chain production processes (#14).

Improvement on all counts is vital for America’s competitive revival.

The investment required for competitive revival and sustained recovery cannot be funded without a long-overdue improvement in US saving. In an era of outsize government deficits and subpar household saving, that may be America’s toughest challenge of all.

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