Is the United States again driving the world economy?
from Dean Baker
In the late 1990s, and again in the business cycle in the last decade, the United States to a large extent was the main engine of world growth. In both cases, growth in the United States, coupled with a rising dollar, led to a growing trade deficit, which provided a boost to demand elsewhere in the world.
There are many who see this pattern repeating based on a pickup of GDP growth in 2014, coupled with considerably faster job growth. This has coincided with a sharp rise in the dollar against other major currencies. However, beyond these outward similarities, there is little basis for the view that the U.S. economy will again be the engine for world growth.
The first and most important reason why this is unlikely is the pickup in growth in the United States is largely an illusion. The economy did grow at a fairly rapid 4.1 percent annual rate in the last three quarters of 2014, but this has to be understood in the context of a first quarter when it shrank at a 2.1 percent annual rate.
The stronger growth of the next three quarters was mostly making up for the negative growth of the first quarter. The first quarter drop was largely driven by weather and other anomalous events, but this negative figure virtually guaranteed that the succeeding quarters would be strong, as the economy returned to its trend growth path.
This is supported by a fourth quarter growth figure of 2.6 percent, which brought the four quarter average to 2.5 percent down from 3.1 percent in 2013. Furthermore, final demand growth in the fourth quarter was just 1.8 percent, as inventory accumulations added 0.8 percentage points to the growth rate.
Looking into 2015 there is little prospect for much of a growth pickup. Recent data on orders for capital goods have been weak. Consumption did surge in the fourth quarter, but much of this was a one-time rise in car buying driven by low gas prices. With car purchases now above pre-recession levels, we are unlikely to see much further growth.
Residential construction seems destined to continue its slow recovery from the collapse of the housing bubble. The government sector will expand modestly, but will not be a major source of growth as the politics of austerity continues to limit spending.
In contrast to the prior two recoveries, there is no asset bubble to act as a driver of growth. In the 1990s the stock bubble created more than $10 trillion in ephemeral stock wealth, an amount equal to the country’s GDP at the time. The housing bubble created $8 trillion in housing wealth in the last decade. These bubbles have not come back and are not likely to in the foreseeable future. This means there will not be a comparable boom in consumption and investment, in the case of the stock bubble, or construction in the case of the housing bubble.
Without the bubble driven demand, there is a limit to the extent to which demand in the U.S. can drive growth in the rest of the world. In fact, the large and growing U.S. trade deficit is likely to be a substantial drain on the country’s growth in 2015 and beyond, if the rise in the value of the dollar is not reversed.
The other point that is often overlooked is the extent to which the U.S. economy has shrunk in size relative to the world economy. This is due to the rapid growth in China and much of the rest of the developing world. Measured in purchasing power parity terms, China’s economy is already larger than the U.S. economy. This means that if the goods and services it produces were sold at the same price as goods and services in the United States, China’s GDP would be larger.
Even on an exchange rate basis China’s economy has grown enormously relative to the U.S. economy. It was just 8.0 percent of the U.S. economy in 1994 and 15.8 percent in 2004. In 2014 it was 59.5 percent of the size of the U.S. economy. The difference between a Chinese economy growing at a 7 percent annual rate, compared with a 4-5 percent annual rate, will matter much to the rest of the world than if the U.S. grows at 3 percent rate rather than a 2.0 percent rate.
In short, anyone who is looking for a boom in the United States to rescue the world economy is destined to be disappointed. The other regions of the world will have to take the steps needed to get their own economies in order, which for the most part means larger budget deficits and lower interest rates.
It is unfortunate that the belief in austerity has come to dominate policy in much of the world. Governments are making painful cuts to infrastructure, education and social services. The main economic impact of these cuts is to slow growth and keep workers from getting jobs. This austerity would still be bad policy in a world where the U.S. had a rapidly growing market for other countries exports. Austerity is a really bad policy in the world we see today.