Morgan Stanley's Stephen Roach tries to wrestle with the facts that (i) the U.S. economy needs short-term stimulus, (ii) the U.S. economy needs long-term government surpluses to boost the country's anemic savings rate, and (iii) he has no confidence in the Bush Administration's ability to even understand what the right policies are:
Posted by DeLong at January 18, 2003 12:33 AM | TrackbackFinancial Times
No way to run the world's biggest economy
By Stephen Roach
Published: January 16 2003The US economy is on the brink of deflation. Thankfully, Washington is trying to come to the rescue. The Federal Reserve has led the way. Now the Bush administration and Congress are set to administer a fiscal stimulus worth $100bn, or 1 per cent of gross domestic product, over the next year.
If anything, this might be too little. With US GDP-based inflation at 0.8 per cent, its lowest for nearly half a century, policymakers should err on the side of excessive short-term stimulus. That can always be corrected if and when the economy is on the mend.
But the US economy also faces profound longer-term challenges. At the top of the list is a chronic shortage of saving - the driver of capital formation and the sustenance of any economy's economic growth. America's net national saving rate - the sum of personal, business and government saving after depreciation is deducted - plunged to a record low of 1.6 per cent of GDP in the third quarter of 2002. That is less than a third of the average of the 1990s and a sixth of the rate of the 1960s and 1970s.
Ever-widening federal budget deficits run the risk of a further plunge in national saving. That trend was evident long before the latest fiscal stimulus proposals. In the first quarter of 2000, the budget was in fact in surplus to the tune of 2.3 per cent of GDP and the net national saving rate stood at 6.4 per cent. By the third quarter of 2002, the budget had swung into a 1.8 per cent deficit - a deterioration in the fiscal balance that accounted for 85 per cent of the depletion in overall national saving since early 2000. Without offsetting higher private-sector saving - not exactly the goal of consumption-oriented policymakers - a steady stream of budget deficits could push national saving even lower.
That would be an unfortunate turn of events. To the extent that US growth cannot be financed by domestic saving, foreign investors must provide alternative funding. The US gets that capital by purchasing goods from overseas, the root cause of its massive trade deficits. Yet, in the end, this is a fool's game. America is running a record balance of payments deficit amounting to 5 per cent of its GDP. Rising budget deficits that lead to a further depletion of national saving will take the external financing gap up to at least 6 per cent, requiring the US to attract about $2.5bn of foreign capital each working day in 2003.
Ever-widening federal budget deficits not only reduce America's ability to finance investment but also leave it increasingly dependent on foreign lenders to close the financing gap. Overseas investors now own more than 18 per cent of the total market value of long-term US securities and 42 per cent of outstanding Treasury bonds - up dramatically since the 1990s. This is no way to run the world's dominant economy. A US short of savings simply cannot afford another era of fiscal profligacy without suffering the results of a sharply weaker dollar and/or a marked correction in other asset prices.
Tax reform, including the elimination of double taxation of dividends, is long overdue. But the Bush administration's proposals need to be judged against the yardstick of national saving objectives. Without a recovery in savings, 10-year revenue loss estimated to be in excess of $360bn would prove hard to bear. Moreover, dividend tax cuts are hardly the best vehicle for a short-term stimulus. Payroll tax reductions would put more cash into the hands of consumers.
Most worrying is the temptation, prevalent in Washington, to use the same recipe that got America in trouble in the first place: overvaluing the stock market, thereby recreating the bubble-induced excesses it prompted in the real economy. Both the Fed and the Bush administration seem more than willing to embrace stock market targeting as a means to jump-start a sagging US economy. And the Democrats' plan urges a stimulus to business capital spending - the last thing that a deflation-prone economy awash with excess capacity needs. This is a film we have all been to before.
The US needs a sizeable short-term stimulus to prevent deflation. But a US economy short of savings cannot afford the luxury of several years of tax cuts and depleted revenues associated with reforms, even if these reforms are long overdue. Nor can it risk the pitfalls of stock market targeting. Those policymakers in Washington who think it can, have yet to learn the lessons of the roaring 1990s.
The writer is chief economist of Morgan Stanley
Low savings is a structural problem with negative long-term consequences; but it's an odd issue to combine with the impending deflationary threat facing the U.S. economy . . . . . if U.S individuals were to promptly begin saving more and consuming less, the resulting downward pressure on near-term GDP might trigger a deflation forthwith . . . . . .
Which is not to say that the two problems aren't both real - they are - but in the short-run more savings increases deflationary pressure rather than reducing it.
For increasing savings, I'd like to see more rational discussion of the U.S. tax disincentive to savings . . . . . to my way of thinking, the income that gets taxed multiple times is any income saved in a (non-municipal)interest bearing instrument . . . . . if major government policies (ie, the federal tax system) actively penalize saving relative to consumption, no one should be surprised that less savings results . . .
. . . . but any change probably would require a phase-in period to avoid generating an unintended "shock" to consumer demand.
Posted by: Anarchus on January 18, 2003 11:25 AMMore macro gobbledygook. If Roach thinks that it's wrong for the Dems to promote investment because we already have excess capacity, then why is he worried about insufficient savings? I've never understood why Mr. Roach is quoted so often, and I am still puzzled.
Posted by: steven postrel on January 18, 2003 12:40 PMMy sense is that Stephen Roach confuses excess capacity with insufficient demand. If I learned it properly from Brad DeLong, the economy can not have excess capacity. The need is for a stimulus to raise demand and so GPD growth to the level of productivity and labor supply growth, say 4.5%.
Stephen Roach has long been a productivity growth skeptic, unlike Brad Delong or Paul Krugman. There is much here however.
Posted by: on January 18, 2003 02:49 PMIn response to Mr. Postrel, I think the concern about insufficient savings is justified. If one believes that foreigners will become increasingly reluctant to finance America's current account deficit -- as Mr. Roach does -- then consumers will be "forced" to save more. Moreover, the shift towards defined contribution pension plans and the looming retirment of the baby boomer generation imply that America's savings rate is unsustainably low.
Secondly, Mr. Roach is quoted so often because, quite simply, he's been more accurate in his productions than the vast majority of economists. He foresaw the decline of the US dollar, the lack of policy traction, and the anemic growth following the recovery from recession. His double-dip thesis may also be crystallizing, with 4Q02 GDP growth apparently tracking below zero (according to JP Morgan).
Posted by: YM on January 18, 2003 06:35 PMerr... I meant predictions, not 'productions'.
Posted by: YM on January 18, 2003 06:42 PMStimilus packages can simply be more or less effective to stimulate demand. If you have a national savings problem, you'd sure want to get as much stimulus mileage out of each $ of national saving (via the government deficit) you're ready to sacrifice. The savings problem is a longer-run problem, but one that a nation can only consistenly ignore at the cost of longer-term growth.
Posted by: Jean-Philippe Stijns on January 18, 2003 08:21 PM"Mr. Roach is quoted so often because, quite simply, he's been more accurate"
Roach was a bear on the dollar and the stock market since at least 1980. He is not accurate. His 2001 prediction of a US recession preceded most Wall Street forecasters, but lagged the yield curve (inverted in Dec 99) and the Conference Board leading indicator. Not very impressive, when a glance at the yield says so much more about upcoming GDP growth and the output gap.
Posted by: Peter vm on January 19, 2003 12:40 AMIs Roach really being all that unclear? Anarchus is concerned that fighting deflation and a low savings rate are mutually exclusive goals, but Roach's text suggests that he is trying to finesse the two problems by getting the timing right. The short term needs effective stimulus, but he thinks one reason a permantent tax cut is the wrong answer is because of its impact on public savings. There are some ready criticisms of a policy that relies on such finesse, but Roach seems pretty clear that he wants one problem solved now, but does not want the cost to national savings to persist in the long run.
Postrel's criticism about savings and excess capacity ignores Roach's worry about the current account. Just because we aren't producing at a level that will induce a lot of capital investment doesn't mean we won't be hurt by the higher interest rates associated with a longstanding Roach (and Greenspan) bugbear -- a sharp slowing in foreign capital flows to the US. Even at a slow pace of capital spending, the US needs that $2.5 billion-a-day Roach mentions.
Roach's pessimism has been based for some time in the notion that the US faces a number of bad choices -- between the need for tax reform, a higher savings rate, avoiding deflation, avoiding collapse in foreign capital inflows. His forecasts may be wrong, or right, depending on when one looks, and he may prove too pessimistic, but I don't think the economic logic in this piece is all that leaky.
Posted by: kharris on January 19, 2003 10:19 AMRemember folks - Brad DeLong's teaching - there can be no excess capacity for the entire economy. The problem is lack of demand.
Stephen Roach has been corrected on this point several times, and chooses to ignore it. Go argue with DeLong and Keynes, I do not care to.
Posted by: on January 19, 2003 11:11 AM>>there can be no excess capacity for the entire economy<<
Ah. This is what I think, yes. But Roach does not agree...
Posted by: Brad DeLong on January 19, 2003 01:41 PMOn the current account business, I agree with the late Herbert Stein: So what? If I run a trade deficit with Japan, my neighbor is not materially affected. When foreigners stop wanting to be paid in claims on future output and start demanding output right away, then prices (and standards of living) will adjust. Given the accounting identity involved, we'll have a more positive current account and pay down our debts. I don't expect this to happen anytime soon given the relative investment potential and transparency of the US, but it is not something to fear in and of itself. As I understand it, almost all of our debt is denominated in dollars, so I don't see a need for huge foreign currency reserves to avoid speculative attacks. So if this foreign bugaboo is off the table, the original contradiction I identified is still there: You cannot complain about excess capacity and still agitate for more savings.
Posted by: steven postrel on January 20, 2003 04:26 PM