by From Dimitri Papadimitriou, Michalis Nikiforos, and Gennaro Zezza In order to understand the US economy – or for that matter any economy – we need to identify its structural characteristics. These characteristics will allow us to link its precrisis trajectory to the present relatively slow recovery and, most importantly, its future prospects. Through this prism, it is also easier to understand major policy debates and concerns regarding foreign competition, such as the recent much-discussed “trade wars”. In several previous reports we have identified four main structural problems afflicting the US economy: (1) the weak net export demand for US products; (2) the fiscal conservatism that has prevailed for most of the last three decades; (3) the increase in income inequality; and (4) the
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from Dimitri Papadimitriou, Michalis Nikiforos, and Gennaro Zezza
In order to understand the US economy – or for that matter any economy – we need to identify its structural characteristics. These characteristics will allow us to link its precrisis trajectory to the present relatively slow recovery and, most importantly, its future prospects. Through this prism, it is also easier to understand major policy debates and concerns regarding foreign competition, such as the recent much-discussed “trade wars”.
In several previous reports we have identified four main structural problems afflicting the US economy: (1) the weak net export demand for US products; (2) the fiscal conservatism that has prevailed for most of the last three decades; (3) the increase in income inequality; and (4) the associated financial fragility.
These issues are not independent of each other. An economy that faces weak net export demand from abroad tends to have high trade deficits. From the financial balances perspective, a trade deficit implies a negative balance (deficit) for the private sector, the public sector, or both. If trade deficits are accompanied by austerity, the burden of the adjustment falls on the private sector. Such an economy faces the choice between growth accompanied by trade and private deficits – essentially growth fueled by private indebtedness – or a recession that will dampen output and reduce imports, thus reducing trade and private deficits. In the former case, private deficits accumulate into higher stocks of debt and make the financial position of the private sector more fragile.
Increasing income inequality makes the situation worse because households at the bottom and middle of the income distribution have higher propensities to consume than households at the top of the distribution. Therefore, a redistribution of income toward the top, as has happened in the United States over the last four decades, has a negative effect on consumption, demand, and growth. In such a situation, for the economy to keep growing it is necessary that poor and middle-class households finance part of their consumption by borrowing. Hence, income inequality adds another layer of instability, as the balance sheets of most households become more fragile (Papadimitriou et al. 2014; Nikiforos 2016).
Finally, such a situation is facilitated by asset inflation, for an increase in asset prices increases the value of the asset side of balance sheets and masks potential vulnerabilities on the liabilities side. As a result, asset inflation contributes to an increase in both the demand for and supply of new liabilities, as both households or other agents are more willing to increase their indebtedness (e.g., loans) and the banks or other institutions are ready to accommodate them. Asset inflation can also have some direct wealth effects on private expenditure, although according to our estimates for the US economy these are relatively small. This analysis shows the connection that oftentimes exists between the two Minskyan processes of fragile balance sheets, on the one hand, and asset inflation, on the other.
The identification of these four structural characteristics of the US economy allows us to understand the factors that led to the crisis of 2007–09 as well as why the recovery that followed has been so slow. In the decades before the crisis, the growth of the US economy (in the face of increasing trade deficits and strict fiscal policies) was largely based on private indebtedness. Due to widening income inequality, the increase in indebtedness was especially problematic for households at the bottom of the income distribution. This process was facilitated by the stock market inflation and the increase in real estate prices, especially after 2000. The crisis ensued when – in the face of high indebtedness – the Fed increased the interest rate and households increased their saving rates; this led to a decrease in growth rates and triggered the financial crisis, which then further reduced growth and employment.
In the period after the crisis, the slow GDP growth rate can be attributed to the same structural factors. Net export demand was weak (with the significant exception of petroleum products) and fiscal policy was constrained (until last year). Inequality also kept increasing. The major difference with the precrisis period is that the household sector has not increased its indebtedness, hence consumption has grown very slowly. Since most components of demand grew slowly (if they grew at all), it is only natural that the economy as a whole also stagnated.
These four structural characteristics are very important for the present and the future prospects of the US economy, warranting more detailed discussion.