The U.S. economy is facing critical long-run challenges that will influence the duration of the credit crunch. For at least a decade, Americans have been consuming far more than they've been producing or saving. They have financed that excess consumption by borrowing from abroad and running up large federal fiscal deficits.
This behavior has led to massive foreign account deficits on top of major federal budget deficits. That imbalance will be aggravated in the next decade by rising federal expenditures for both social security and health care as the baby boom generation retires.
From 1946 to 1985, personal consumption averaged 62.8% of U.S. real gross domestic product (GDP). It averaged 66.7% from 1986 to 2000, 70.3% from 2001 to 2007, and reached a high of 71.6% in 2007. In contrast, net U.S. exports of goods and services fell from an average of 0.3% of GDP from 1946 to 1985 to negative 1.8% from 1986 to 2000, and to negative 5.1% from 2001 to 2007. Consequently, more than 90% of the rise in consumption spending from 2001 to 2007 consisted of greater net imports of goods and services.
Paying the piper
In 2007, our balance of payments deficit was 6.7% of GDP. A major cause has been the low level of American savings. The Department of Commerce states that personal savings as a percentage of Americans' personal disposable income was a meager 0.6% in 2007. That figure does not include increases in home equity as savings though most American households definitely count such equity gains as their own savings.
During the housing price run-up from 2000 to 2006, millions of Americans used their gains in home equity as ATMs, for purchases often unrelated to housing. That helped drive personal consumption spending to high percentages of GDP.
Beginning in 2008, our excessive spending was drastically curtailed by the recession. Most households can't draw cash from home equity because the market value of their homes has been falling and they've already borrowed heavily.
In addition, through November 2008, more than 2.7 million Americans had lost their jobs since December 2007, pushing the U.S. unemployment rate to 6.7%.
Finally, the stock market fell sharply during 2008, eliminating a large share of the financial assets accumulated by American households. From Jan. 2 to Dec. 5, 2008, the Dow Jones Industrial Average fell 33.8% and the S&P 500 index declined 39.36%, wiping out trillions of dollars of wealth in the United States and around the world.
Meanwhile, many retailers have been forced to lay off workers or file for bankruptcy. Firms supplying consumer goods, including automobiles, also have posted major declines in sales and profits, and that in turn has forced employers to shrink payrolls. Thus, the downward spiral in financial activity has led to a downward spiral in economic production.
Delicate balancing act
This situation has motivated incoming federal officials to focus on increasing U.S. household consumption and employment in order to slow down the recession's negative effects. A conflict will inevitably emerge between the long-run need to reduce American consumption below its recent excessive levels and the short-run need to stimulate consumer spending.
The Obama Administration has proposed a compromise in the creation of a federally financed investment program in infrastructure improvements to provide many jobs to unemployed workers.
The dilemma illustrates that recessions have a positive role to play in business cycles. A function of every recession is to wash out of the economy many financial excesses that build up during long periods of prosperity.
The Obama Administration needs to generate a positive anti-recession spending program to offset that pain. But it also needs to change America's long-run balance of consumption, savings and investment to one based on our ability to pay for what we consume from our own resources. Achieving that basic shift without experiencing extreme transition pains is the formidable task facing the new president. It won't be easy.
Anthony Downs is a senior fellow at the Brookings Institution and a visiting fellow at the Public Policy Institute of California. He can be reached at [email protected].